Are you aware of the impacts financial projections for startups can have on long-term success?
According to Fundera, about 20% of small startups fail within their first year and roughly 50% by their fifth year. Beyond poor product-market fit, running out of cash is a leading cause of failure for many startups. Cash flow and other financial performance issues are frequently a result of poor planning or a lack of reliable financial projections.
Financial projection is integral to strategic planning for a business of any size. It’s also a central element of accurate forecasts and plans. These projections provide a breakdown of estimated sales, expenses, profit, and cash flow to create a vision for the startup’s future.
Moreover, robust financial projections are essential when seeking investors or loans. Many potential financiers want to see pro forma statements and sensitivity analyses assessing the impact of higher or lower sales on revenue performance on the income statement, cash flow document, and balance sheet.
This post covers the above topics and provides a breakdown of the essential components of startup financial projections.
Gathering the Necessary Data
A comprehensive forecast requires a robust historical basis, making data collection an essential first step when making a reliable financial projection.
Next, decide on your key assumptions and inputs for the forecast. Projected sales volume and estimated operating costs are great places to start. Consider a conservative approach when evaluating future revenues and expenses if your historical data is limited.
In addition, in-depth market research and industry benchmarks can provide relevant data points by helping you identify consumer trends of your targeted demographics.
Revenue Financial Projections for Startups
For many small or bootstrapped startups, the top line figure, revenue, will be the most sensitive metric. Demand for your products and services will constrain what you can afford to spend on:
- Product development
- Other operating costs
A robust method for estimating future revenue involves balancing past performance, current trends, and long-term objectives. Trend and regression analysis of historical data are popular methods for identifying patterns and drawing relations between different factors and revenue.
Financial projections must focus on more than just the past. Part of the forecast involves identifying factors aimed at revenue growth. For example, according to the Entrepreneur and the Pareto principle, 20% of your customers contribute to 80% of business sales. Expanding your offerings to get those top customers to buy more can be a powerful strategy for boosting sales.
Expense Financial Projections for Startups
Because expenses are often largely predictable, planning for them can be more straightforward than with revenues. Typical initial-stage fixed costs include office rental, some employees or contractors, insurance, and utilities.
You likely also have some costs that vary based on how much service you use or your level of sales. Lawyer fees, consulting, and marketing are variable costs not linked to your sales, while hourly wages (i.e., for direct labor) and merchandise will increase or decrease depending on your sales volumes.
Together, these fixed and variable costs represent most of your operating expenses.
Historical data, plus an adjustment for inflation and increased consumption, will provide a solid basis for startup expense financial projections. Further, these assumptions help you identify potential avenues to trim expenses or find efficiencies while increasing your revenues to drive your startup’s success.
Cash Flow Projections
The next step in your projections involves cash flow. Instead of historical data, your revenue and expense projections will be the basis for your cash flow projections. This forecast combines incoming cash totals, including investments and profit, with expected outflows.
Breaking the forecast down by month will help you analyze cash flow patterns and identify potential gaps. A clear cash flow forecast showcases your business’s financial health.
Financial Statements and Ratios
The final step for your financial projections for your startup involves using your expense, revenue, and cash projections to create income statements, balance sheets, and cash flow statements. These statements serve several vital purposes.
They are documentation you can provide to potential investors or lenders. Perhaps more importantly, these statements allow you to calculate and analyze key financial ratios to check your health. There are five elemental financial ratios to evaluate your startup, including:
- Efficiency ratios measure a startup’s resourcefulness and performance of its assets and liabilities.
- Liquidity ratios analyze the startup’s capability to repay a debt through its assets and liabilities.
- Leverage ratios weigh a startup’s debt levels compared to other financial metrics, including assets.
- Market value ratios assess the startup’s current stock share price.
- Profitability ratios highlight a startup’s capability to create profits through its assets, balance sheet, equity, and operating costs.
Graphs and charts of these ratios provide an easily accessible visual representation with insights into revenue growth and cash flow.
Need Help Creating Financial Projections for a Startup?
Financial projections for startups are potent means for piloting a company in the right direction. A sound forecast helps you see what’s on the horizon and what to focus on.
Because the world is constantly changing, regularly update and refine your financial forecast to maintain accurate metrics for correct projections.
Are you convinced of the value in financial projections for startups but need help figuring out where to start? Feel free to seek professional advice and use digital tools to build accurate and effective predictions—Founder’s offers financial forecasting services to scale up your startup. Contact us today to start figuring out what the future holds for you.