Starting with a blank slate and a very important task at hand? Let me explain how I can help you prepare financial projections, including:
- Underlying Value
- Why Financial Projections
- Financial Statements
- 4 Types of Analytics
- Industry Research
- Income Statement Forecasting
- Balance Sheet Forecasting
Who should dive into preparing financial projections? Every single business leader alive today.
How to Prepare Financial Projections
In my years as a corporate finance professional, particularly working in Mergers & Acquisitions and Investor Relations, I’ve seen a lot of financial projections. In most cases the financial projections I’ve seen have been flawed in many ways. This is important. Financial projections are a vital component to running a business – used properly they keep everyone in an organization accountable and keep your business sustainable. The point is meeting revenue and profit expectations so you can afford to do it again, over and over. It’s called growth and it should be a top priority for everyone in your organization. Follow these guidelines on how to prepare financial projections.
This begs the question. Why prepare financial projections in the first place?
Great question, right? Why bother? Let’s start with the one universal truth about all financial projections. Ever – past, present and future. All financial projections are wrong. It’s just a matter of which direction they’re off and by how much. The objective is to prepare realistic financial projections that come close to actual results. Do this and you will gain credibility with your stakeholders.
All financial projections are wrong. It’s just a matter of which direction they’re off and by how much
Knowing this fact is the best place to start. Preparing financial projections knowing they will be off gives you an edge. This will help you separate facts from assumptions when preparing your company’s financial projections. Detailed financial projections are important because they will be shared. Similarly they become a benchmark for expectations. Expectations for your organization, your investors and buyers in merger and acquisition transactions. This is the underlying value of financial projections.
Related: What to Expect From Your M&A Advisor
The end goal? To be able to effectively come up with a systematic process that ensures you get that elusive opportunity everybody’s vying for: the chance to ignite consistent, sustainable revenue growth that can be shaped and changed by different tactics and industry trends.
Who should dive into financial projection strategies? Every single business leader alive today.
Whether your company is only but a fledgling startup or you happen to be a mogul already, you must always be able to prepare reliable financial projections to maintain financial health, identify new opportunities for incredibly profitable customer retention and continually grow your business.
Why Financial Projections?
Why would anybody, any organization, any investor want management to spend their time creating a view of the future they know will be wrong? Because the process of preparing financial projections will teach you and your team more about your business than any other activity. It’s not a one time thing. By engaging in a full-blown Financial Planning & Analysis (FP&A) process, your entire organization will learn how to prepare financial projections and achieve them.
Because the process of preparing financial projections will teach you and your team more about your business than any other activity
You can take it even further if you leverage an Objective & Key Results (OKR) system for your strategy development and execution.
The first step is to establish the reason for preparing financial projections. There are 3 primary categories. Think of it this way: all exercise is good exercise. It’s why you practice. To perform with consistency when it matters. The more everyone on your team understands how your financials work, the more accurately you can plan for growth.
Never forget that accounting is about the past, finance is about the future. You can’t make good business decisions looking backward. You also must know where you came from.
Reason 1: Organization & Operations
It’s your business. Make the most of it by knowing your numbers. Set goals, track every move, cost and investment you make pursuing them. Know whether you hit them or not. Analyze the negative impacts to your plan and rework your strategy to mitigate those risks. Then go for it again. Do this every month and you will see patterns that enable bigger goals.
All businesses have to keep track of financial results in order to file accurate tax returns and maintain federal and state compliance. This is accounting. But accounting is about the past, finance is about the future. Preparing financial projections is planning for the future. Think of this as your business plan financial projection. Knowing what factors influence your business and what flexibility you have to navigate the business process landscape will improve your chances of success.
Planning for the future takes place in the present and is largely based on alignment strategy. Use an Alignment Map to measure your Product (or Service) / Market fit, your Finance / Market fit and your Organization / Market fit. What you find will amaze you.
First we need to assess the status of our resources. What we have to work with will influence what we can achieve. Think capacity, for example. If you make widgets, you have limited capacity of production volume, limited labor, limited working capital and limited time. All businesses, whether product or service have limitations. Establish what your business limitations are to understand where you have, and where you need agility. You can only produce what your limits will allow.
Everyone in your organization must contribute to either revenue or profit in one way or another. Either they’re in sales and generate revenue, they’re in operations and contribute to productivity (visible as profitability) or they’re in finance and analyze accountability. Knowing this, you can establish what your survival team looks like. What skills you need on your team to be unique and deliver your value proposition.
Functions outside your survival team can be outsourced.
To effectively assimilate the financial goals of your organization into your org chart and influence productivity and success you will need realistic financial projections.
Reason 2: Investor Relations
If you have investors, as a private or public company, you will need to communicate to some extent with them. What do investors want to know? Investors want to know whether you are achieving your goals or not. They have expectations about the value of their investment in the future. And you are responsible. This doesn’t mean that investors only want to know about your financial projections, they also want to know about other meaningful achievements, benchmarks and setbacks.
This is the role of financial projections in investor relations. Set reasonable expectations. Think about it, the better you know your numbers, the more realistic you can be, it’s called guidance after all. It’s alright to miss your projections as long as you are close and have a reasonable rationale as to what happened.
How much detail you provide in your financial projections with investors is another discussion, it varies given each company’s unique situation. The thing is, once you provide select information it will be expected consistently in the future. The financial projection line items, and any other KPI figures you select as meaningful and insightful about your business progress should remain the most important each time you report to investors.
Don’t disappoint investors by changing the metrics you report from period to period. Factors may evolve over time, your intimate understanding of your business shouldn’t.
Reason 3: Mergers & Acquisitions
Whether you are on the buy-side or sell-side of an M&A transaction, valuation is the single most important variable impacting success. And guess what? Valuation is largely based on a buyer’s perception of the future. How can you accurately value a business without viable financial projections?
Related: Business Valuation Spectrum
Above all, the role valuation plays in mergers & acquisitions cannot be understated. Neither can the quality of historical financial information and other relevant KPIs. Historical facts are the basis for a company’s financial projections. Using Key Performance Indicators to support your financial projections will only help build credibility. Time will tell if your outlook was accurate at the time the financial projections were prepared.
Internal and External Factors
Understanding and measuring what matters will enable you to discern between internal and external factors that impact your financial performance. Selecting the right financial ratios and non-financial analytics will help you pinpoint productivity and profitability opportunities while mitigating risks.
Internal factors could include leadership, organizational structure, communication, customer satisfaction and churn.
External factors that affect your organization may be technological, economic, social or political. The same internal factors that lead to an organization’s success inevitably characterize its relationship to the external environment in these broad areas.
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Key Performance Indicators
For instance, picture an eCommerce business that has experienced consistent revenue growth over the past three years, with a supporting trailing twelve month (“TTM”) trend. What other data would we want to compare to the same periods to draw a reliable cause and effect conclusion? You got it: Google Analytics will give us pretty much everything we want to know about the company’s conversions. If the selected KPIs don’t support the historical analysis, find the right metrics – it’ll save you in the long-run.
Mergers and acquisitions transactions depend entirely on accurate financial analysis to identify synergies, accurately value the target and identify advantageous deal structure alternatives and financing options. This depends on reliable historical financial analysis and a strong understanding of future revenue, cost and expense drivers; i.e. how to prepare reliable financial projections.
Sellers want to maximize enterprise value. Buyers want to maximize synergies. Both of these motivations impact business valuation. By this I mean the approach to business valuation; what factors are measured in the equation.
These are the two opposing views in every prospective M&A deal. If you are a seller, make your business as attractive, synergistic and valuable to your best buyer. If you are a buyer, establish what your business is missing given your growth trajectory and go find it in a growing company.
Buy versus build is the rationale behind mergers and acquisitions.
How much is your business worth? What a willing buyer and a willing seller agree to. So how do you determine an accurate business valuation?
Determining an accurate business valuation for an M&A target, or seller, depends on many variables and changes constantly based on internal and external factors. To begin, fundamentally sound financial, economic and market driven approaches should be defined. Then the data needs to be assembled in a business valuation financial model.
Company Specific Value Factors
Identify company specific value enhancing factors, industry wide benchmarks and trends, and financial and economic perspectives on valuation and risk considerations. This mission-critical analysis is purpose built to identify financial and capitalization opportunities, in addition to incorporating the inherent characteristics of the many sources of financing alternatives into the future growth outlook.
Begin with a thorough examination of your company’s (the target’s) operations, management and organization structure, financial history, market position and future financial outlook. The core objective is to inform management and shareholders as to the Company’s true market value, relative to comparable investment opportunities, by highlighting the potential return on investment given industry specific valuation parameters and risk tolerance.
Assemble the following components:
- Detailed business description
- Business & industry analysis
- Historic financial analysis
- Detailed financial projections with supporting drivers and data
- Valuation analyses
In How to Best Position Your Company for the New Year we pointed out the importance of assessing your resources, creating influence and evolving your perspective. Similarly, when preparing financial projections, you have to work with facts, not fiction. This is easier if you’ve been in business for a while, than if you are early stage. Even if you are at an early stage, you can establish a price range for your product or service and estimate market size, penetration rates and conversion assumptions to get started.
Planning and preparation forces you to focus, to consider the cause and effect relationship between investments of time and money, and outcomes. But don’t forget the relationship between the three financial statements. Yes there are three interconnected financial statements you can never forget about.
The 3 Financial Statements
- Balance Sheets
- Income Statements
- Cash Flow Statements
The first two are required for anything and everything. You can’t have one without the other. The Cash Flow Statements add a quick view of financial activities details that are nice to see, but may not be critical at all times.
You have to have insights as to what you expect to happen in the future, how you plan on taking advantage of opportunities and how you plan to mitigate risks to avoid mistakes. You have to do this for yourself, your employees and your investors.
A balance sheet is a snapshot in time showing you the value of your assets, liabilities and shareholder equity. It’s a great financial statement to help you understand what resource volume you need on hand for cash management and to offset costs and expenses when revenues are light or uncertain.
The balance sheet also keeps track of your liabilities: money owed to vendors, lenders, etc. The difference between your assets and your liabilities is your shareholder equity: the book value of what would be left if you closed the doors and walked away.
An income statement provides you a summary of financial activity including sales, costs and expenses over a period of time, like a month, a quarter or a year. This helps you see profitability in a single period and it enables you to see trends when comparing relevant periods against one another.
For example, comparing month-over-month income statements will enable you to see revenue growth or decline, changes in cost of sales and differences in operating expenses. All of which will impact profits.
Cash Flow Statements
A cash flow statement is essentially an analysis of the relationship between a balance sheet and an income statement. This statement starts with the very last line item of the relevant Income Statement for the period: Net Income. Then it lists corresponding Balance Sheet figures for the relevant ending period to show changes (incoming vs. outgoing) cash in the following three business functions (cash flow from):
Historical Financial Analysis
The value of analyzing historical financial statements is to determine cause and effect relationships between your business activities and financial outcomes. Top and bottom line. The better you understand how your daily approach to business impacts how much you sell (Revenue) and keep (Net Income), and will enable you to begin thinking about accurate financial forecasting.
Normalized Financial Statements
To begin, normalizing, recasting or whatever else you want to call it is a good step to preparing and reviewing monthly, quarterly and ad hoc reports. This process will educate you and your team as to aberrations from standard business activities. To prepare normalized financial statements, using three columns (in a spreadsheet) present actual, adjustment and adjusted (normalized or recast) results. You can do this for both the balance sheet and income statement.
The purpose of this exercise is to establish good and bad results from trying new things, one time charges, non-recurring expenses and so on. It’s essentially a backward looking “what if” scenario on actual results to provide you insights into the future. If you can mitigate risk and avoid mistakes will you save money?
You want to predict with confidence so you can provide insight into financial plans, business performance, expected future results, expense management and project milestones.
A well established financial analysis program will support the assessment of budgets, forecasts and business plan performance. This includes probability drivers, risks and opportunities as well as enabling recommendation actions to identify value creation opportunities and improve business outcomes.
Starting at the top of your Income Statement(s) will highlight sales performance. Your sales and operations teams need leadership to achieve sales and profit goals. You can provide effective analysis of various data sources to identify trends, opportunities and challenges.
Common Size Analysis
Another process providing tremendous insight to your organization’s finance/market fit can be achieved using a common size analysis. Common size financial statements help to analyze and compare a company’s performance over several periods with varying sales figures. The common size percentages can be subsequently compared to those of competitors to determine how the company is performing relative to the industry.
It provides insight to organizational productivity and profitability optimization, while identifying specific areas of misalignment with industry standards.
Depending on where you are on the life cycle curve (e.g. startup, growth, IPO) you will be focused on different key performance indicators (KPIs). This is why understanding each respective type of financial statement is critical. Early stage businesses need to pay strict attention to their balance sheet, because cash is their runway.
Without cash it’s hard to make much progress. Companies in growth mode need to stay focused on expanding revenue, but also need to watch cost and expense trends to optimize productivity and profitability. Companies that have “made it” and are ready to go public (IPO phase) have an entirely new level of financial acumen to answer to.
Your financial projections will serve growing purposes as you move along the life cycle timeline.
The more adept you and your team become at preparing financial projections, the more you will be able to guide your growth and profitability.
Key Performance Indicators
Accompanying the presentation of financial analytics will be all the other relevant Key Performance Indicators. What I mean by relevant KPIs are those non-financial measures that you can consistently rely on to support indications of productivity. Which analytics are right for you?
There are tons of non-financial KPIs out there that can help keep your financial projections realistic. Think about how you solve a jigsaw puzzle. First, start with the corners. Second, establish all four borders. Lastly, work towards the center until you complete the entire picture. This logic works wonders when preparing financial projections.
4 Types of Analytics
There are four types of analytics that will give you relevant insights to your productivity beyond financial ratios. These are:
- Descriptive Analytics – these report what happened
- Diagnostic Analytics – these report why something happened
- Predictive Analytics – these report what could happen
- Prescriptive Analytics – these report what should happen
This is a major topic for its own post, which is coming soon. Here’s a high level glance at the types of non-financial ratios and analytics that will help you keep your financial projections viable given data driven perspective.
Analytics come in four distinct types, each building on the other and supporting the next: descriptive, diagnostic, predictive, and prescriptive.
The foundation of all KPIs is descriptive analytics, which report what happened and allow analysis of past performance data in order to identify known strengths and weaknesses. A descriptive report for every business, for example, could show how many product or service units a company sold last month in different market segments.
The next level is diagnostic analytics, which report on why something happened and reveal what factors drive positive and negative performance. If your company’s descriptive report shows that sales are down in one market, a diagnostic report might show that it’s because of reduced marketing spend.
With those as our foundation, we can use predictive analytics to report on what could happen, based on past performance. If you want to increase revenue, its predictive report could show where higher marketing spend would go farthest to convert more sales.
At the very top we have prescriptive analytics, a report on what should happen. Here, artificial intelligence and machine learning mine past data to inform future decisions. Prescriptive data could tell your marketers exactly which price points to push in their upcoming campaign.
Your marketing team will appreciate your ability to develop plans and programs to support the achievement of required results, maintain and grow lead volume, evaluate new channels and business opportunities.
The data is available. You just need to use it well to prepare analyses (financial and other types) for monthly board-level reporting decks that include dynamic financial modeling, full financial statements, comprehensive Key Performance Indicator (KPI) reporting and summary analyses of key business trends. These could include operational dashboard reports, actual versus budget variance narratives and decision-making recommendations.
Year over year and trailing twelve months (TTM) comparisons will provide you with in depth financial analysis and models to allow for business decisions and ensure compliance with corporate initiatives and goals.
Coloring inside the lines is important if you want to present a clear picture of your view of a viable future growth path. Every industry has experiences trends, constraints and rules of practice that you will have to recognize when preparing financial projections.
Remember the four categories of non-financial analytics? Each industry will also have its upper and lower limits of specific measures that you will also have to comply with.
Start small – list your closest competitors (public and private) and find, as best you can, their respective historical revenues for the same periods you prepared for yourself: past three fiscal years and TTM. Under each revenue figure for it’s period, calculate the growth rate percent so you can see how fast each competitor is growing. Once you prepare this analysis for each one, you can look at means and medians for all of them combined for each given period.
You can also correlate growth rates with relative revenue mass. It’s easier to grow at 50% per year when your revenues are $1 million, than when your revenues are $25 million. There are plenty of KPIs you may want to track. They are different for every industry vertical and are a topic for a different discussion.
Industry Research Reports
Preparing at least some level of industry research will give you perspective on upper and lower limits of the growth your are striving to achieve. It will also add credibility to your financial projections when sharing them with anyone.
Third party industry research reports are also a good reference for accurate industry growth rates, KPIs and other trends. Trade associations and equity analysts at investment banks are good sources for third party research.
Income Statement Forecasting
Projecting an Income Statement or set of periodic Income Statements (e.g. monthly for 12 periods) requires a fundamental understanding of the business economics relevant to your product or service, organization makeup and customer engagement process. Typically this requires a detailed review of like-period historical income statements (month to month, quarter to quarter or year to year).
The level of line item detail will depend on your business and who is using the information. For example, revenue could be broken down by product or category, while operating expenses could be broken down into multiple line items delineated as fixed or variable.
Fixed v. Variable
The expenses you will incur on a daily monthly, quarterly and annual basis will categorized as either fixed or variable. Fixed expenses are those incurred regardless of sales volume, and could include line items like rent, salaries & wages, utilities, technology (cell phones, data plans, software subscriptions), insurance, etc. These are items that have a flat recurring periodic (e.g. monthly) charge and remain consistent given a specified time horizon (e.g. lease or contract period).
Variable expenses are incurred as a result of sales increases, expansion plans or other growth related investments, and could include line items like advertising, marketing, travel & entertainment, bank service charges, professional fees, etc. These items may be foreseeable, but ultimately will vary from month to month.
The more detailed you can be with individual line item identification, the more precise you can be with your income statement projections. However, as a rule of thumb, limit your total operating expense line items to no more than 30 total.
From the top of the Income Statement to the bottom, you need to maintain integrity and accuracy with the estimates for sales, costs, expenses, margins, profits and interest and taxes to make the exercise worthwhile.
Any number of people could be using your income statement forecasts to make decisions about your business. It is important that you have an understanding of what information the projected income statement is providing and what that information means to different people.
Let’s start at the top of the Income Statement and take a look at sales projections. Reminder: any recent historical data you have is a great place to start. Even going back a full three fiscal years and the most recent trailing twelve months will provide you with facts to work with. This is how we present a sell-side M&A business in a confidential information memorandum.
Forecasting sales begins with unit economics and the expected volume of conversions – both recurring and new. Again, if you have historical sales data to use as a basis, it will make your near term forecast more reliable. Either way, understanding your total addressable market will be a key parameter to keep your sales projections viable.
Product or Service Categories
If you have more than one product or service for sale, list your product or service categories, with each respective sublist of products or services, like this:
I know it seems a bit too simple, but it is a starting point for any kind of business. It’s also great to keep things as simple as possible – it facilitates great communication, which is paramount to executing strategy, investor relations and mergers & acquisitions. Keep your business clean, keep your customers happy. It’s that simple.
What you are going to do with these is create income statement projections with your top group called “Revenue” where you will itemize each of these by unit and price. Along with these two metrics there are additional analytics we can use to add insights including percent growth, etc.
Once you determine your TAM, establish a realistic sales process, cycle duration and estimated conversion ratio (e.g. 1:x will buy within y days/weeks/months from initial dialog). You may want to implement a kanban board to complement your sales tracking process. Next, determine the expected repeat purchase rate and add this to your sales projections:
- New Customer
- Repeat Customer
This will lead to some very important analytics, including:
- Customer Acquisition Cost (“CAC”)
- Life Time Value (“LTV”)
But these analytics are ratios that involve not only Sales data, but also select operating expense data. The next set of financial projection data we will need to consider includes Cost of Goods Sold.
Cost of Goods Sold
Cost of Goods Sold (“COGS”), or Cost of Sales, refers to the cost to you of the product you are selling. This is usually product specific (not service), pertaining to manufacturers, distributors and other resellers. On you income statement projections worksheet make a copy of the product or service categories list and sublist, and underneath your Revenue projections create a corresponding set of cells for each category and list and name the entire section “Cost of Goods Sold.”
Scale is a fundamental concept when it comes to COGS. In theory, the more you buy the lower the unit cost. This will happen on a step basis at volume intervals. Keep scale in mind and use volume intervals as benchmarks to help you determine your sales forecasts. The more you grow, the more margin you can earn.
Remember, Gross Margin is the other side of the coin from COGS – it’s what left over.
Operating expenses are best thought of as fixed and variable. Fixed expenses are the burn you have to take on regardless of sales volume. These line items will include expenses including rent, utilities, salaries, software subscriptions, etc. Variable expenses are taken on as needed to fuel sales. These types of expenses involve advertising, marketing, travel & entertainment, customer service, etc.
Watch these carefully to correlate good spending versus bad when forecasting sales. The best way to allocate spending on operating expenses is keeping every line item at a healthy, productive percent of projected sales (common size). Because you have to spend before you sell, accurate information and attention to actual versus projected results will be key to ongoing decision making.
While there are thee primary profit perspectives (EBITDA, EBIT and Net Income), keep EBITDA at the forefront of your income statement projections as the key profit component. The key reason is due to impacts to balance sheet factors, which we’ll move on to now.
Balance Sheet Forecasting
Balance sheet forecasting is more complicated than income statement forecasting for a number of reasons. First, your balance sheet has no time horizon, unlike your income statement. Rather, your balance sheet is always evolving with short term (less than one year) and long term (more than one year) financial commitments growing and declining.
A balance sheet is a snapshot in time of your assets and liabilities. This is the reason for the rest of the challenges with balance sheet forecasting. And it’s the reason to consider diving deep into the four categories of analytics mentioned earlier. They will help you assess accurately the relationships between your activities, sales and expenses and your company’s financial health – which what your balance sheet measures.
The goal is to maximize your assets and minimize your liabilities. Every day, week, month, quarter and year. This is how to build lasting enterprise value, even if your balance sheet only reflects the book value of shareholder equity.
Related: Business Valuation Spectrum
Similar to your income statement projections, the most sensible approach to your balance sheet projections starts with reviewing historical periods – the same dates as your income statement periods ended. By preparing the historical analysis you will be able to see two significant data points that indicate trending:
- Increase versus Decrease
- Amount as a percent of Revenue
This will allow you to determine the level of historical health and set target goals to incorporate into your balance sheet projections.
Current Assets are expected to convert to cash within one year.
Cash & Equivalents
Your starting cash balance as the date of your opening income statement period is an important focal point. It should be enough that you won’t ever have a capital call for additional cash – either equity or debt. But these things do happen.
For an operating company you just start with the amount of cash your business has in the bank and move on to the next line item. For a business plan, cash may be the last number you put into your balance sheet projections. The easiest way to figure out how much cash you could need is to pick a number, plug it in and go through the rest of the financial projections to see how cash fares given your other assumptions. Then adjust accordingly.
Proceeding with future period cash projections will depend on the level of profitability you project and your intended investment into growth. You will have to account for interest (on the income statement) and principal payments (with short and long term liability calculations) on debt. You may be able to plan for dividends or other shareholder distributions if you produce a cash surplus.
All of your financial projection assumptions work together to calculate your projected free cash flow, so this is a very important item to keep an eye on in this process.
A/R can vary significantly depending upon the type of company you are running and the terms you extend to customers. There are also collection issues that can happen to any business.
The most common measure of Accounts Receivable is days sales outstanding (DSO), or the average number of days that it takes a company to collect payment after a sale has been made. DSO is often determined on a monthly, quarterly or annual basis, and can be calculated by dividing the amount of accounts receivable during a given period by the total value of credit sales during the same period, and multiplying the result by the number of days in the period measured.
A high DSO number shows that a company is selling its product to customers on credit and taking longer to collect money. This may lead to cash flow problems because of the long duration between the time of a sale and the time the company receives payment. A low DSO value means that it takes a company fewer days to collect its accounts receivable. In effect, the ability to determine the average length of time that a company’s outstanding balances are carried in receivables can in some cases tell a great deal about the nature of the company’s cash flow.
The inventory turnover ratio is an efficiency ratio that shows how effectively inventory is managed by comparing cost of goods sold with average inventory for a period. This measures how many times average inventory is “turned” or sold during a period. In other words, it measures how many times a company sold its total average inventory dollar amount during the period.
Inventory Turnover = Cost of Goods Sold / Average Inventory for the Period
Forecasting inventory by calculating expected turns will provide you with insights to efficiency and cash needs.
Any prepaid expenses you incur should be presented in real dollar amounts. If your business has high frequency prepaid expenses – deposits that are paid and satisfied – you may want to calculate the forecast figures in each period as a percent of sales, represented in dollars.
Other Short Term Assets
Any other short term assets that your business carries on its balance sheet can be calculated and forecast the same way as prepaid expenses. Calculate the forecast figures in each period as a percent of sales, represented in dollars.
Fixed assets are not expected to convert to cash within one year of the balance sheet date.
As you invest in fixed assets you will need to follow GAAP depreciation rules to ensure tax compliance. While most business accounting software packages support all the different depreciation schedules, you may want to defer to your CPA before tax season, just to make sure your accounting is accurate at every month end.
Nevertheless, forecasting fixed asset investing, depreciation and book value of net fixed assets can be done with a simple straight line depreciation schedule.
Other Long Term Assets
As with your fixed assets, any other long-term capitalized asset, like intellectual property, will need to be GAAP compliant. Short of having your CPA confirm you are depreciating, or amortizing other long term assets appropriately, your projections can reflect a simple straight line depreciation schedule over the life of the asset.
Current Liabilities are expected to be paid within one year.
Accounts payable (“A/P”) could be thought of as the offset of Accounts Receivable in the context of preparing financial projections. Handled properly a company can free up cash by paying its accounts down in the same time it takes to get paid. This rule of thumb makes projecting A/P simple – just match the days outstanding to A/R.
Line of Credit
If your business uses a line of credit the simple way to project future expected balances will be to analyze relevant past periods (monthly, quarterly, annually) to extrapolate the most relevant ratio (line of credit/revenue, loc/inventory, loc/A/R, etc. Use this ratio to project line of credit balance assumptions.
Current Portion, Long Term Debt
The current portion of long term debt is the amount due within one year of the balance sheet period. Classify this as current, while the remaining balance of long term debt is a non current liability.
Advances, Accrued Expenses
Any deposits you take from customers will be presented here. Remember to convert these liabilities to revenue when its proper to recognize the money as such.
Any tax liabilities you expect to incur and pay within one year of the balance sheet period should be projected in this line item.
Non Current Liabilities are not expected to be paid down within one year of the balance sheet date.
Long Term Debt
This is where you will present the amortization of long term debt you have, or plan to take on in the due course of business.
Other Non Current Liabilities
Any other long term liabilities you expect to carry should be projected in this line item.
That’s it. Your financial projections are complete.
While every business is different, and the circumstances for every business change with time, following a disciplined process to prepare financial projections on a periodic basis will keep your organization accountable. It will also teach your organization details about your business, industry and competitors that you otherwise would never realize.
There are a lot of reasons to prepare financial projections. None is more important than preparing financial projections for you and your team.
About Ian Shanno
Ian Shanno is a corporate finance enthusiast that has worked in Mergers & Acquisitions, Investor Relations and Management Consulting on around 500 engagements covering a ton of ground. He helps companies advance their productivity and profitability by making improvement suggestions in different functional areas to achieve measurable results, attain transparent investor relations and increase enterprise value. He also helps sellers maximize value in a sale and helps buyers achieve maximum synergies in mergers & acquisitions.