Developing accurate financial projections
Every small business will need to make reliable financial projections at one time or another. This forecasting is critical at many stages of a company’s life — when it is looking for financing, when it wants to gauge the potential profitability of a new product or service, when it wants to see the impact of staff expansion or cutbacks, or when it needs to assess other important business decisions. Coming up with reliable projections isn’t guesswork. It requires you to analyze market research, trends, and business assumptions to come up with a reasonable forecast. When you’re done, you’ll have a realistic idea of costs and profits. Use these guidelines to begin the process. Determine your expected market share Research your industry to determine the total market for goods and services like yours. This figure can serve as a base for determining the percentage of the market your company can realistically expect to capture, which is your expected market share. Multiple factors can influence expected market share, like the amount of competition already established in your area, the number of distributors you have in place, and your industry’s growth rate. It’s important to analyze the market carefully to come up with the most realistic projections possible. Be sure to document any trends you uncover. Add up business expenses Account for the amount of money that will be flowing out of your business each month. In general, these expenses will be in line with your industry’s norms. There may be circumstances, however, that make your company’s expenses in a particular area higher or lower than other businesses’ expenses. For example, if you buy parts domestically and most competitors have contracts with less expensive overseas vendors, your expenses for materials may be higher than the industry average. Identify a realistic business growth rate To come up with reliable financial projections, you’ll need to estimate a reasonable growth rate for your business. You can do this by reviewing industry growth figures and spotting market trends that may affect sales going forward. Keep in mind that most businesses grow gradually. Assuming skyrocketing sales in your first three months of operation is likely to label you as a novice to investors and lenders that review your projections. Also, if your figures are at odds with your industry’s norms, turn a critical eye to them. If there is a reason they are higher or lower, such as an existing contract that guarantees a specific monthly income or high seasonal sales, document these unusual circumstances carefully. Provide multiple scenarios Building out different financial outcomes for your business can give you a more accurate picture of the revenues you can expect. Develop a best-case scenario that assumes the most aggressive growth rates, as well as a worst-case scenario that takes into full account potential risks. Between these two extremes will be the most likely financial scenario for your business, which is likely to include gradual business growth and both planned and unanticipated expenses. This exercise will show potential investors and bankers that you understand all the factors that will influence your company’s success. Back up your assumptions To be confident in the figures you come up with, back them up with solid research and reasoning. If you plan on 50 percent revenue growth during your first year, demonstrate how that growth will happen. Are your projections based on industry norms? Will you run extensive marketing campaigns? To provide additional support to your assumptions, do some basic first-hand market testing of your concept. Talk to an accountant Review the results of your calculations with your accountant or financial advisor. He or she can tell you if they are in line with generally accepted accounting guidelines and your industry’s norms. If they’re not, your advisor may be able to recommend ways to adjust them.
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