6 Steps to Creating Realistic Financial Projections

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Well-crafted financial projections are a crucial component to any business plan. They will help you make informed decisions about your business and give you a realistic idea of how much money you need and can expect to earn in the future. Financial projections are also critical if you are seeking funding from lenders or investors.

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Your financial projections, which include your projected income statement, balance sheet and cash flow statement, are heavily based on the assumptions you input. For example, if you assume the average price for each unit you sell is $100, your projections will be vastly different than if you assume an average price of $50. Likewise, assuming your payroll will grow at 5% annually versus 20% will dramatically impact your projections in future years.

So, how do you create the most realistic financial projections? The answer is to conduct the appropriate research. Below are the six key things you must research to create the most realistic projections.

1. Research your market size

Clearly, you can’t project that you will achieve revenues that surpass the size of your market. As such, you should start by determining your market’s size. Most industry associations publish research regarding the size of their industry.

As appropriate, you should multiply that size (which is usually done on a national basis) by the percentage of people that live within a reasonable radius of your storefront to determine your local market size.

2. Research industry pricing

While, certainly, you can be the premium-priced provider in your industry, you still must research competitive pricing to ensure your prices are reasonable. Start by identifying the top players in your market. Then visit their locations and/or websites to determine how they price their products and services.

3. Research gross margins in your industry

Gross margins are calculated as price minus cost of goods sold. They are the amount of money you have left after subtracting the cost of goods sold from your revenue.

Particularly for a startup, your cost of goods sold may be difficult to precisely determine. But you can estimate them by researching the prices of the raw materials or components you need to produce your product or deliver your services.

In addition, you should look at the annual reports and 10-Ks of any public companies in your space. They will show those companies’ gross margins. The gross margins you use in your financial projections generally shouldn’t be significantly higher than those.

4. Research the salaries you must pay

An important line item in your income statement is the salaries you must pay your employees. To get an accurate estimate of this cost, you should research the current rates for the positions you need to fill.

You can find comparable salary rates online. See what other companies are paying for similar roles. For example, if you are seeking an office manager, search for office manager positions in your area and see what salaries other companies are paying.

5. Research the costs for site buildout and equipment

Particularly if you’re starting a new business, you might need to factor in the cost of site buildout and equipment in your financial projections. This can be a significant expense, so it’s important to get accurate estimates.

You can search online to get estimates for new and/or used equipment you’ll need to purchase. For design and buildout, though, you should speak to local designers and contractors. Have them give you estimates so you gain a solid understanding of the precise costs you will incur.

6. Research potential growth rates

Even if you accurately estimate each of the items above, you can still create very flawed financial projections if your growth rates are unrealistic. For example, assuming an average annual growth rate of 20% versus 5% will dramatically impact your projections in future years.

So, how do you most accurately estimate growth rates? To begin, you should assess how growth rates affect other areas of your business. For example, if you require 2,000 square feet of space and 10 employees to serve 100 clients per day, what are the requirements for serving 500 employees per day? Would you need to open a second facility? Would you need to hire five times as many employees? If the answer is “yes” to both of these questions, that’s fine. But you’ll have to factor that into your financial model as launching new facilities and hiring and training new employees takes time, both of which may slow down your growth plans.

The other way to estimate your growth rates is to assess larger companies within and related to your industry to see what their growth rates have been. While it’s possible you’ll be the fastest growing company ever, that’s unlikely. So, get a good estimate of other companies’ growth rates, and estimate your rate within that range.

By conducting the appropriate research, you can be sure your financial projections are as accurate as possible. This will give you the information you need to make sound decisions about your business and increase your chances of success. It will also give you credibility in the eyes of investors and lenders. They will appreciate your diligence and be more comfortable investing in your company.

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