This is the 2nd blog post in my series of posts about Financial Projection Basics. If you want to start from the beginning, make sure to check out “What are Financial Projections.”
Today I want to get to the “Why” behind financial projections. I often here questions or statements like this:
- Aren’t financial projections just a blind guess for a startup? What is the point of wasting our time?
- Financial projections are just created to give the bank a reason to deny my loan request.
- I don’t need anything more complicated than back of the napkin math for my projections
- I am not an Excel expert, so I don’t know how to create projections easily so I won’t waste my time.
I think there are 3 primary reasons that you should create financial projections whether you are a brand new startup or an established small business owner:
3 Reasons Why You Should Build Financial Projections
1. Proof that your business could work
Before you sink your retirement account and your valuable time into starting a new business, don’t you think it would be worth spending a couple hours to build some basic financial projections that will help prove whether your business can be profitable?
A great exercise is to work through is a Breakeven Analysis. I have written extensively about this topic and provided a free breakeven analysis template here.
Basically what you do is determine a sales price for your product or service, determine how much it will cost you to produce 1 unit of that product or how much it will cost to provide 1 hour of that service, and then take your sales price minus your cost to produce to come up with your Gross Profit per unit.
Then add up all of your monthly overhead like:
Take your total overhead divided by your gross profit per unit and you will come up with the number of units or billable hours you need to sell each month to breakeven.
Now this is really important!
You need to do a gut check here. Let’s say that you sell used cars in a town of 1,000 people and your breakeven analysis shows that you need to sell 50 cars per month to breakeven. That is 600 per year. Do you think you will be able to consistently sell 50 used cars per month in a town of 1,000 people?
So before you drain your retirement, just go through some basic projections to determine whether this business has a chance of success.
2. Projections are an important exercise that all big businesses go through
Have you ever invested in a publicly traded company? Have you noticed that the stock can skyrocket or tank based on the company beating or missing their earnings projections by a couple of pennies? Just look up any publicly traded company and you will find SEC filings with forward looking projections. These companies create projections not simply because investors want them, but because it helps them plan internally.
Projections can help you determine when to hire that new staff member, when to add a new piece of equipment, or how much you need to increase prices to reach profitability.
If you want to grow into a big business someday, it isn’t a bad idea to emulate what they do, like creating projections.
3. Investors, lenders, and partners will want to see your projections
Are you looking to raise investment? Will you need a loan someday? Are you thinking about bringing on a business partner? Based on our current ProjectionHub users we know that sharing financial projections with investors, lenders, accountants, and business partners is one of our most popular features. It is important to keep a set of up to date financial projections ready for when an investor, lender or business partner asks to review your projections. It provides a sense of confidence when I, as a lender, ask to see projections and the business has already completed their projections before I asked. It shows me that this business owner is taking this seriously.
So those are the 3 key reasons why you should take a bit of time and create a set of financial projections. Whether you use our tool – ProjectionHub – or simply use an Excel template, this is a process that is worthy of your time and effort, it will save you a lot of pain and headache in the future as a business owner and set you on the path to success.