The preparation of financial projections for startups and financial projections for established businesses need different approaches.
Established businesses have a history of past performance which can be analyzed and used together with any newly developed financial plans and targets to produce its financial projections. However, startups, by their very nature, have no such history, and different methods need to be adopted.
Developing Financial Projections for Startups
In the absence of performance history, startup financial projections need to be based on your aspirations for the business, on the targets, goals and milestones you will be setting, and on the action plans you will be developing. These are of course (or should be) contained within the business plan.
Financial projections for startups, are simply a statement in monetary terms of the ideas developed within the business plan.
The first step is to decide what you need to spend to get the new business up and running, ready to start producing and selling goods and services. This will include startup expenses, such as website design, rent, insurance, marketing, payroll, and startup assets such as office furniture, computers, and machinery.
This is all happening before you have your first customer and revenue, so the next step is to decide how these startup expenses and assets are going to be paid for using a combination of equity and debt finance.
Having established what is needed to get the business up and running, it is now necessary to use the information in the business plan to show in monetary terms how the business intends to survive, and how much money it will need before it reaches the break even point. This is done by estimating the operating expenses of the business based on the business plan, and dividing this by the gross margin percentage for the product or service.
For example, if a business plans to sell a product for 40 which costs 16, then the gross margin and the gross margin percentage are calculated as follows.
Gross margin = Selling price - cost Gross margin = 40 - 16 = 24 Gross margin % = Gross margin / Selling price Gross margin % = 24/40 = 60%
If based on the business plan, operating expenses are likely to be 90,000 a year, then the revenue needed to break even is calculated as follows.
Breakeven revenue = Operating expenses / Gross margin % Breakeven revenue = 90,000 / 60% = 150,000
The business then needs to consider whether the calculated break even revenue of 150,000 is achievable in the short term (1 to 2 years), and if not adjust the product gross margin or the operating expenses until it arrives at a break even revenue which is both realistic and achievable.
Allowing for the limitations and constraints on resources such as finance and staffing levels, contained within the business plan, it should now be possible to estimate the time it will take to reach break even, and more importantly to estimate how much money is needed to fund the losses in the business up to this point.
Assuming for example, the business plan shows a growth rate of say 250%, with a first year revenue of 24,000, it can now estimate revenue in years two and three as follows.
Growth rate = 250% a year Year 1 revenue = 24,000 Year 2 revenue = 24,000 x 250% = 60,000 Year 3 revenue = 60,000 x 250% = 150,000
It should be noted that year 3 revenue is the same as the breakeven revenue calculated earlier.
Based on these revenue numbers, it can also estimate losses for each year as follows.
Profit = Revenue x Gross margin % - Operating expenses Year 1 loss = 24,000 x 60% - 90,000 = -75,600 Year 2 loss = 60,000 x 60% - 90,000 = -54,000 Year 3 breakeven = 150,000 x 60% - 90,000 = 0
The combined total of losses for years one and two amount to 129,600 which needs to be funded until the business reaches break even. If the growth rate turns out to be higher or costs lower, then the business will reach break even earlier and need less funding.
Financial projections for startups tend to be a lot less stable and predictable than those for an established business. Nobody knows whether the growth rate in the above example will be 250% each year or whether the costs will remain at 90,000. As the months progress, the startup business will be able to gather history about its performance, and identify whether it is on plan or not. In addition, by using the monthly history it will be able to revise the initial financial projections to make them more accurate and reliable.
The important point is that however inaccurate, the financial projections are based on and supported by the objectives and milestones in the business plan and allow the business to think logically and strategically about its future plans, and to quantify the amount and timing of resources needed to achieve its goals and targets.
Financial Projections for Startups Template
The financial projections template is a useful tool for generating initial financial projections for startups as it allows the revenue, gross margin, and operating expenses to be quickly amended until the business shows a break even position within the constraints of the resources established by the business plan.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.