Entrepreneurs are optimistic.
As I was chatting with one of my banker friends last week, he made a comment that over the last 10 years he had only seen a couple of financial projections from a business owner that projected that the company would lose money. He speculated that in reality a majority of those businesses actually lost money at least for a year or two.
He was probably right.
As outlined in this report by the American Enterprise Institute the average person believes that companies earn an average profit margin of 36%. In reality the average profit margin across 200+ industries is between 6 and 8% as seen in the graph below:
3 Ways to Determine Whether Your Projections are Too Optimistic
So if you have completed a set of projections with our tool – ProjectionHub – now you need to do a reality check and see if your projected profit margins are reasonable. There are 3 key things I think you should do:
Step 1 – Check your Bottom Line
The first thing you need to do is calculate your projected profit margin. You can do this in ProjectionHub after you create a set of projections then go to the Dashboard and view the Income Statement Report.
You will then be able to find the numbers you need to calculate your profit margin. Profit Margin = Net Income / Total Sales. So if you have $100,000 in sales the first year and $15,000 in net income, then your profit margin would be $15,000/$100,000 = 15%
Remember the average profit margin across 200+ industries is only between 6 and 8%.
Step 2 – Check your Growth Rate
Next you should check your monthly sales growth rate. There is a question on Quora that is helpful here. The question is aimed at web-based startups, but I think it can be helpful for your business no matter your industry. The question is “What is a typical user growth rate for a hot web startup the first year?” The answers are very helpful. You can see Facebook’s average revenue growth rate per week for 2004 through 2012. I think your goal should simply be to calculate your growth rate and make sure it is less than Facebook’s growth rate. There are a lot of startups that create projections that make it look like they will set the world on fire in 3 years. Facebook was not a billion dollar business overnight and yet it was one of the fastest growing businesses ever, so just do yourself a favor and don’t embarass yourself by projecting a sales growth rate faster than Facebook for your coffee shop, mobile app, or consulting firm.
Step 3 – Compare to Industry Ratios
A great way to determine whether your projections are reasonable is to compare to industry average ratios. BizStats is a great tool to find this information. For example, below you can see the average key ratios for a business in the Restaurant Industry.
As you can see the average profit margin is 6.33%. It sounds so easy to open a restaurant and make such a great profit, but that is not the norm. You can have a nice business with a 6% profit margin, but before you risk your life savings to start a new restaurant, it is important that you know what you are getting yourself into.
If you haven’t created a realistic set of financial projections yet, I encourage you to give our tool (ProjectionHub) a try here and make sure that you go through a reality check to make sure your projections are 5 times too optimistic.
If you have any questions or need any help along the way please don’t hesitate to reach out to me directly – Adam Hoeksema – adam@projectionhub.com
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