Financial Projections are defined as estimates of a how a company well perform financially during a set period of time in the future.
Financial projections are typically done on an annual basis and are a vital part of any business. The formal projections are typically not nearly as important as the process of the projection itself. This strategic planning establishes a clear plan and goal that can be followed during the year. Time can be made to stop and review where you are in relation to the plan and adjust course, if necessary.
This planning will also help your company weather internal and external changes that affect the company. Taking the time to make these plans, and to honestly evaluate both your company, the market and your competitors will help you to identify problems and opportunities, so that you can make the necessary adjustments. Careful planning will allow you to take full advantage of any new development, rather than leaving you stumbling in the dark and hoping for the best.
The pitfall with financial projections is that they can easily become routine exercises that are lacking the necessary insight. There are three strong reasons to take the time to carefully prepare financial projections.
Goals are important in all areas of life, and the financial plan takes a broad goal and makes it a well-defined target. Knowing what specific outcome you are shooting for can help you achieve it. This plan will also help you make a commitment to meeting the stated goal, and it can also help you set milestones that will help you gauge how close you are to your goal and where you might need more work. Feedback and control are also major aspects of the business that can be provided with the financial projections. When you begin to see big variances from the expected projections, you will know to look closer to determine what the problem is. The financial projections can also give you an important framework for clarifying what the total impact of the variance will be, as well as how the variance could be offset or otherwise corrected. Finally, the financial projection is important in helping you anticipate potential problems with the business. For instance, rapid growth can create challenges with the cash flow and a properly prepared financial projection will show this. Any assumptions that are worked into the projections should be clearly spelled out. Most company’s develop several different types of projections and budgets to meet different needs and objectives.
One common model is the annual projection that works either with the calendar year or the company’s fiscal year. With an annual plan the forecast should be reviewed and updated monthly, allowing it to be a useful tool for planning and monitoring the company’s growth and success. This plan allows the information to be used for creating other forms of financial planning. One important plan is a long-range financial plan that looks ahead three to five years. These long-term plans are important for maintaining the company’s strategic goals, while the short-term plans are effective for short-term, immediate expectations. Startup companies should have monthly plant for at least the first year, and then annual plans for the next three years or longer. Many companies choose to use quarterly plans during the early years, rather then going straight to annual plans. The numbers can be added to, showing the next several years. However, it is important that the numbers are truly investigated and are not just extrapolations of the current year. The long-term projections should be made using strategic planning. Budgets typically cover a single year at a time. Detailed actions, targets and target dates should be clearly listed in the budget. The specific plans for achieving the goals, including staffing and expenses, should be clearly listed in the budget. The company’s size will largely determine whether the forecast can reasonably be used for the budget. Some companies will require more work on the budget process. Either way, annual budgets are usually frozen when they are approved. For continued success, budgets must be consistent with the financial plan and the should help the company work towards its long-range plan. Cash forecasts are also needed. The budget and annual financial forecast can be broken into greater detail with the use of cash forecasts. This report focuses on cash flow, not net profit, and may include periods that are short as one week to that potential fluctuations can be spotted ahead of time and addressed. The time units for the projections should be no larger than a month at a time, and should go forward for one year at the minimum. Additional years can be included, but the detail for those only needs to be broken down to the quarter for the following year, and then annually after that.
Income statements and balance sheets should accompany every projection. Expenses can be grouped by branch, department, or expense; or expenses can be listed in greater detail with a line-item expense listing in the budget. A statement of cash flows can be included to clearly show cash needs and forecasted cash flows. Financial statements that include financial rations or show expenses as their corresponding percent of sales should have this information calculated and included in the projections.