How to make financial projections

How to make financial projections

In fact you cannot realistically evaluate your business concept without examining its potential profitability in advance of starting. 

To determine what financial return you may achieve you will want to create a projection of the profit or loss of the business for its first year. And you will want to estimate the amount of cash that will come into the business and what amount will go out. This is known as a cash flow projection.

Let's look at each of these projections.

Making a Sales Projection

One of the hardest tasks you face before you open for business is to estimate what your sales will be by month for the first year in business. This is particularly difficult because to gain the greatest use from this projection you should do it 3-6 months before you launch. There is no magic formula for making a sales projection, but we have some suggestions.

The first step in projecting sales is to do enough research into your business to determine if there is a seasonal pattern to the sales. Articles about your type of business, interviews with other business owners and financial statistics collected by trade associations are helpful in determining what level of sales is produced during different times of the year. Department stores, for example do more than 40% of the total years sales in November and December. Use this information to determine what percentage of sales you are likely to do each month of your first year.

Second, go back to your business description and marketing strategy to describe which one or two of your products will produce the majority of your sales. Determine what the "unit of transaction" will be for them. For example, if you are a consultant the unit of transaction is fees/hour or fees/day. A retail store might have a unit of transaction of so many boxes of a product/transaction. Using the promotional strategy you created earlier, estimate how many units you might sell in month one of your business; month two and so on.

The third step is converting you unit sale estimate into dollars. By now you should have developed your pricing--either a single fee per hour or a price list of various products or services and their prices. Multiply each month's unit sales estimate by your fee per unit or use an average of your different prices. This produces your dollar sales projection per month. 

Estimating Your Expenses

If you have completed your research on start-up and monthly operating expenses, you should have a reasonably good idea of your expense categories.

Expenses come in two varieties:

1. Fixed expenses. These are cost that you have whether you have any sales or not.
2. Variable expenses: Money you spend to get new customers and to make and deliver your product or service are your variable expenses.

Some expenses must be paid each month; others are due just once per quarter or possibly twice per year. In a vertical column next to Month I of your sales projections, write in "Operating Expenses" and fill in each fixed and variable expense you feel you will pay your first year.

Calculating Profit

There are three kinds of profit you deal with in business:

There are three kinds of profit you deal with in business:

1. Gross Profit. This is the dollars of sales left after paying for the materials or inventory used to produce the sale. In businesses selling their time, labor or knowledge their gross profit is usually equal to their sales, since there is no cost of product involved.
2. Operating Profit. This is what is left of gross profit after you pay your monthly operating expenses (including your personal compensation). Interest on loans and taxes are not deducted. 
3. Net Profit. This is your sales income left after all expenses, interest costs and taxes to your state and Uncle Sam. This is the profit left to put back into growing your business and to possibly pay yourself a bonus!

Sales often materialize more slowly than you estimated and your expenses often run higher than you estimated.

The Cash Flow Projection

The projection form used for cash flow looks very similar to that used for the profit and loss projection.

• Starting Cash. Unlike the Profit and Loss Projection, where we are only interested in sales and expenses each month, the Cash Flow Projection also takes into consideration the amount of cash you initially invest in your business. This amount is filled in the "Starting Cash" block on the projection form.
• Cash Sales.
• Credit Sales Collected. After your first month in business, you will hopefully receive payment for sales where you granted credit. When you receive the cash you record it in this row. 
• Monthly Cash Flow. To arrive at the final outcome of the cash that came into your business in a month's time and the money that was paid out, you take the total of the "Starting Cash" for the month, cash sales, credit sales collected, any other cash in, such as interest and subtract the total of cash paid out during the same month. The result is the "Monthly Cash Flow."
• Accumulated Cash Flow - After the first month, you add this months cash flow-positive or negative--to the previous months cash flow to see how you are progressing throughout the year.