How to Create Financial Projections

By James Chittenden

Novice entrepreneurs often feel intimidated by business planning, especially creating financial projections. A business education or an accountant is helpful, but not required. Start with a realistic idea of anticipated expenses and costs. You also need a realistic idea of the revenues needed to cover all expenses.

An experienced business owner and accountant has a good idea of how to create financial projections. After all, if a business has operated for some time, it will have a track record of expenses that management can can use to reasonably predict the future financial performance of the business. However, a startup has no such record, especially a startup with a relatively untested concept. However, a new business owner can follow a few simple guidelines to determine how to create financial projections that serve as a foundation for a solid business plan.

First, know some basic financial vocabulary.

The following terms are from the One Click Advisor Business Glossary. Items that consume cash are red. Items that are cash or generate cash are green. The statements are blue.

Accounts Payable (A/P) is money owed by a company to its creditors. Commonly referred to as “payables”.

Accounts Receivable (A/R) is money owed to a company by its debtors. Commonly referred to as “receivables”.

Assets are any resource owned or controlled by a business or other economic entity that can produce positive economic value. See Balance Sheet

Balance Sheet is a financial statement that lists the assets, liabilities and equity of a business during a defined period (monthly, quarterly, annually). Equity is the “net worth” of the business. The balance sheet is the basis for evaluating the capital structure of the business. 

Assets = Liabilities + Equity. -OR- Assets – Liabilities = Equity.

Cash Flow Statement shows the amount of cash that enters and leaves the business during a defined period (monthly, quarterly, annually). Unlike the income statement which only shows business activity, the cash flow statement shows all cash, which can come from sources such as investors, owners, and proceeds from loans.

Income Statement is a financial statement showing profit and loss from business activity. It is a listing of revenues and expenses during a defined period (monthly, quarterly, annually) and shows how revenues translate into net income, or profit. Commonly known as a profit/loss (P/L) statement. The terms are used interchangeably.

Liabilities are defined as obligations owed; debts incurred as a result of past transactions. See Balance Sheet.

Profit/Loss (P/L) Statement is a financial statement showing profit and loss from business activity. It is a listing of revenues and expenses during a defined period (monthly, quarterly, annually) and shows how revenues translate into net income, or profit. Commonly known as an income statement; the terms are used interchangeably.

Pro-Forma means financial statements that are projections of future expenses and revenues, based on a company’s past experience and future plans.

Recommendations from a CPA

Tony Morales is a Certified Public Accountant (CPA) at Miami area-based FinTax . We asked him for some tips on creating financial projections.

Tony Morales CPA
Tony Morales, CPA
What are some recommendations for a pre-revenue or startup owner who is trying to create financial projections?

TM: “I would recommend a startup obtain and look at their direct competitor’s financial statements as a barometer of expectations. If they do not have access to such financial statements, then I would recommend they obtain a market analysis of their industry and set realistic expectations based on factors like the market size and composition, relative to their capital contribution and initial efforts to enter the market. I would recommend that regardless of either methods employed, that they only pro forma financial statements up to a maximum of 3 months and quickly revise and adjust their forecasting as actual operations begin. You don’t ever want to run the risk of relying on false data to make business decisions – as those often prove to be the most costly!” 

What is a simple process for projecting financial statements?

TM: “You first start by ensuring the accounting cycle is complete and current. This means you have to make sure cash and credit cards are reconciled, A/R and A/P properly reflect their balances and all remaining Balance Sheet items are addressed (such as accruals and prepaid items). Once you have a current set of financial statements, you’ll want to extrapolate the remainder of the calendar/fiscal year, usually on a monthly basis.

For example, pretend today is July 10th, 2023. You’ve updated and compiled financial statements as of 6/30/23. You print those financial statements on a monthly basis, showing balances for each month, all the way through December 31st. The months of July through December will initially have no data (since these are the future months), and you must rather look at each month and consider what each category item will be based on the historical data. Most commonly, you will average out the previous 6 months (Jan-June) and enter that in for each month thereafter. But this does not always make sense, especially when you have frontloaded expenses in the year or extraordinary items that are not recurring.

You must consider these factors on a month-to-month basis to properly build a set of pro forma financial statements that have logic and reasoning applied to them. You should be able to defend your numbers with logic/reason when sharing them with third parties and explain the reason why you believe the number(s) will be what is shown.”

What are a couple of advantages and disadvantages using Quickbooks for developing pro forma financial statements?

TM: “Some advantages include the fact that you’re presumably working within the accounting software that houses all of your financial data. It is relatively simple and easy to generate reports through Quickbooks and export them to Excel for manipulation.** Some disadvantages include the fact that you must manually build the pro forma financial statements (normally though Excel), as Quickbooks does not have forecast/budgeting capabilities. Because it is a manual process, Quickbooks cannot help ensure your work is done properly and therefore you must rely on experience and expertise to determine whether the pro forma financial statements are sufficient.”

** Click on Excel and Quickbooks for discounted pricing.

Fixed Costs are Never Really “Fixed”

“Fixed” costs are widely misunderstood. The business must pay them regardless of sales. They include rent, insurance, phone, internet, salaries, and other regular, recurring costs. The amounts of some of these costs may stay constant for a period of time due to leases or other contracts. However, keep an eye on these monthly bills, as you may not always receive notice of changes. 

Variable costs 

Variable costs rise and fall with sales. They include items such as parts, ingredients, labor, or transportation expenses. Since sales cannot be accurately forecast, neither can the costs associated with those sales. 

Step 1

Add up all of your fixed costs, and update it each month. Watch your bills and account for increases or decreases in your phone bill, rent, salaries, insurance, etc. Use this business budget calculator or free template to track these costs, and easily carry them over from month to month. 

PRO TIP: “Miscellaneous” is a line item and the amount should be as high as possible. This should cover unexpected expenses. If you budget for $500 in miscellaneous costs and earn the revenue to cover it, whatever is not used becomes operating profit.

PRO TIP: Be liberal when predicting expenses, and be conservative when predicting sales. Think of “thirds”. Take all of your meticulously planned expenses. Now triple them. Now imagine your best marketing projections of first year sales. Reduce that to about 1/3 of what you planned.

If you can still make a profit, consider the plan workable.

We have created a book that walks you through expenses of operating your business, complete with fillable pages. There are many other costs and not all of these will account for your unique situation.

If you are trying to figure costs, see Small Business Cost Helper and the One Click Advisor Business Builder

Step 2

Set a profit goal for the month. How many dollars would you like in your pocket at the end of the month? How much would you like to re-invest in your business? Whatever that is, add it to your fixed costs. 

Yes. Treat your profit like a fixed cost. That way you can set sales goals that help you provide for all the money you need to pay your bills and take home some profit. 

For example, Joe owns a coffee shop with fixed costs of $10. Joe would like to make a $5 profit. Joe should plan to sell enough coffee to have $15 at the end of the month.

Step 3

Set sales goals that cover all fixed and variable expenses. In order to do that, you need to know what margin you need to collect. 

In this video, you will learn exactly how to set your goals and meet them, including profit:

MANAGE PRICES BY MARGIN, as opposed to simply setting markups. For an explanation of markup vs. margin, see here and watch the videos. 

If you are a service business and not a retail business, you still have costs that include the hourly rate of yourself and employees, along with costs of travel, laptops, or other expenses. Set margins in accordance with your industry. Learn more hereMargins for professional services have averaged 30 percent in recent years. 

And finally…

Welcome to One Click Advisor! We would be remiss if we didn’t give you a brief tour of the site and what it can do for you, as an owner of a startup or small business. You can sort your challenges and opportunities into one of three areas.

Marketing, because it brings in the customers. That requires the right combination of price, product, promotion and place

Operations, because it keeps your customers. A well-run business pleases customers and generates steady and reliable revenue. But to be well-run, you need reliable providers

Finance, because it is the scoreboard, and keeps everybody paid. Change the “score”, find bookkeeping help, and find capital

The One Click Advisor Business Builder connects you with all the fundamentals. Skip the hours of research and costly mistakes…we have done the work of locating the best small business services for you.