Preface: Financial projection assumptions require a wide scope of professional knowledge and financial judgment. Here’s what you need to know before preparing projections for your next major business decision. Cash has a source; plan before you write checks.
Financial Projections
Whether you’re raising capital for your business from bank financing or investor capital, financial projections are often required as an important tool to paint the projected financial future of your business subsequent to obtaining the capital from the source(s), and assessing the corresponding cash investment in your enterprise.
Financial projections begin with assumptions about your business marketplace and environment that require a wide scope of knowledge about factors specific to your industry, e.g. competitive conditions, market sensitivities and conditions, accounting policies, and regulatory conditions. But the scope of knowledge doesn’t end there, in addition, for accurate financial projections, you must identity past performance patterns for the business (or businesses, if projections are for a merger or synergistic acquisition) and trends in revenues, expenses, financial metrics, i.e. cash flows and performance ratio’s, and management performance contingencies.
CPA prepared projections are often for limited use, such as a regulatory agencies review or specific bank negotiations. More so, the more experienced the team, e.g. your CPA firm, assembling the financial projection, the greater the accuracy. Financial projections are based upon hypothetical assumptions that form the basis of the projection. Forming hypothetical assumptions is the first technical step of a projection. The hypothetical assumptions are the nucleus of projections and require profession judgment. This includes assumptions of top line revenues (sales), cost of goods sold, and operating expenses. These metrics are acquired from insights gathered assessing marketplace landscape from the scope of knowledge listed. Once the hypothetical assumptions are formulated, a projection projects next step is to form the financial projection. This can be either a short-term or mid-term projection for the periods relevant to the projection. A short-term projection is measured in months, and a mid-term projection is measured in years.
Preparation of the financial projection should include a statement of position or balance sheet for the period(s), statement of revenues, expenses, and retained earnings, or an income statement for the periods, and statement of cash flows. You will need standard financial metrics from your industry to compare to your projection for feasibility and realistic achievement probabilities.
Although the assumptions are hypothetical, the reality is they need to be realistic. Their will be real dollars on the line if you achieve anticipated loan credit or investor capital. Don’t fast on your due diligence budget. A smart investment in planning your future with financial projections, can improve the quality of the ultimate decision. Once you’re entirely committed with attorney signed documents, you want to minimize surprises. You should always work with a CPA or business advisor when preparing projections to increase the professional scope of knowledge and judgment in your financial projection.
Understanding cash flow is a major component of a projection. Will you have cash flow to support the business until revenues exceed breakeven or accounts receivables are collected? Is your business diversified in your marketplace or are your projection assumptions indicating major customer risks, or do they contain certain price sensitivities, or is the repayment period adequate? Once you have your projections prepared, scrutinize and review thoroughly. After all, hypothetical assumptions are not indicative of actual financial results.
Summary: Financial projections are often prepared in anticipation of major financial decisions in business. Realistic projections require a wide scope of knowledge and professional judgment. Work with your CPA firm and/or business advisors to achieve realistic projections, and professional judgment on your financial projections decisions.