Whether you're launching a business from scratch, or managing an already established company, it pays to have a grasp of how the future might look.
Being able to understand what your financials will look like over the next few years can help you to better manage your business today. For example, looking to the future can help you:
- Understand whether you need to raise funding, or take on debt, in order to fuel your growth.
- Decide how much capital you can afford to dedicate to long-term projects, like new product areas or R&D.
- Manage your staff count, so you can ensure your wage bill rises in line with revenue growth.
How do you know what your financials will look like in future though? This is where financial projections come in.
What are financial projections?
Financial projections are a way of estimating what your company's financials will look like at various points in the future. A financial projection will typically project a number of different financial metrics forward, but the key ones are:
What will your company's income look like going forward? Will it grow? How will it grow - linearly, exponentially, or in steps as you sign specific deals?
How will your costs change over time? Are you running a business where the majority of costs are up-front, or are they recurring? How do they scale with revenue growth?
Expenses can be further split into:
- Cost of Sales
These are the expenses that are necessary in order to generate revenue. If you're running an ecommerce business, for example, the costs of producing or acquiring the goods you sell will fall into this category.
- Operating Expenses
These are the costs that your business accrues which aren't strictly necessary in order to generate revenue. Continuing with the ecommerce example, marketing spend will fall into this category.
More complex financial projections
Above are the basic metrics that a financial projection will typically forecast. From this starting point, financial projections can forecast more complex numbers like your:
- Gross Income
Your revenue minus cost of sales, before tax.
- Tax Bill
How much tax you're likely to pay each year in the future.
- Net Income
What your post-tax income is going to look like going forward.
- Cash Flow
How much cash you're likely to be holding at each point in the future.
Why are financial projections important?
We talked earlier on about some of the decisions that financial projections can help you make, but it's worth emphasising that financial projections are important for external reasons too.
If you want to attract investors, or get a loan from a bank, you'll need to persuade them that your business has a safe financial future. As part of these processes, it's likely you'll be asked for some form of financial projection.
It's therefore a good idea to get into the habit of building regular financial projections. Not just so you know what the future of your company looks like, but also so you can communicate that with anyone else who you need to educate on your business.
How do you make good financial projections?
Financial projections can differ greatly from company to company, but there are a couple of key features that all good financial projections have in common:
Good financial projections don't just pull numbers out of thin air, rather they're grounded in historical data. If your company's revenue has been growing at 20% YoY, any future projections should be based off of this fact. You shouldn't project ahistorical revenue growth without a good reason.
All financial projections make assumptions. It could be the assumption that your expenses next year will look the same as they do this year, or the assumption that you'll land a deal worth $x in 6 months time. Whatever these assumptions are, it's critical that anyone reviewing your projection can see and understand what they are.
Accounting for uncertainty
The future isn't certain, so why should your financial projections be? This is one of the most common errors in building projections; assuming that you know exactly how the future will unfold.
The chance of you exactly predicting next year's revenue is virtually zero, so a good projection won't spit out a single revenue number. Instead it'll give a range, or probability distribution, of possible revenues for next year. This helps stakeholders understand how confident you are in your projections.
One of the reasons it's hard to make good financial projections is that they often depend on how discrete future events play out. What if we open a new office in New York? What if we lose our biggest client in the next year?
A good financial projection should let you understand how these scenarios would affect your future financial. Typically this is done by building different scenarios within your projection. These scenarios can then be used to answer all sorts of questions about how future events will impact your financials.
What's the best way to make financial projections?
If you're looking to build a financial projection, you've got a couple of options at your fingertips.
Most businesses use a spreadsheet-based tool such as Excel or Google Sheets to build their projections. While the popularity of spreadsheet-based tools makes these projections easy to share, they come with a couple of significant downsides:
- Spreadsheets don't like playing with your data
With a few exceptions, it's generally quite hard to build spreadsheets projections that update based on historical data. Being a primarily offline tool, Excel struggles with incorporating any live financial data you have. Google Sheets doesn't make it much easier (unless your data is already in Sheets).
- Spreadsheets are ugly
Who hasn't been felt the rush of 'uggh' when opening someone else's complex, multi-tab spreadsheet. It can often take ages to understand the logic behind a spreadsheet, and how each cell relates to the others.
- Spreadsheets are exact
Chances are you've not built a spreadsheet projection that can account for uncertainty before. This isn't anyone's fault; spreadsheets really do make it difficult. They're built for exact forecasts, which assume you know exactly how the future will unfold.
- Spreadsheets don't like answering questions
It's not just uncertainty that spreadsheets struggle with, they're also not equipped to answer questions like how will my cash flow differ if I start hiring for a new team? To answer questions like this in a spreadsheet, you'd typically have to build out your projection twice; once for each scenario you're interesting.
If you're new to building financial projections, or are reaching the limits of spreadsheet-based tools, it could be worth trying to build your projections in Causal.
Building financial projections in Causal
Causal is a browser-based modelling tool which lets you build financial projections in minutes.
Instead of creating huge spreadsheets full of countless rows and columns, Causal is built around Variables.
You can start off by creating input variables like current revenue and then create variables which define how your inputs change over time (e.g. revenue growth).
Causal fixes one of the major problems with spreadsheets, by being able to account for uncertainty about the future.
Maybe you don't know that your monthly revenue growth will be 4%, but feel confident that it'll be somewhere between 3 and 5%. Causal lets you build variables that account for that uncertainty:
With these simple ideas, Causal lets you build any kind of financial projection. You can extrapolate variables forward in time, build scenarios in just a few clicks, and share your model in an interactive dashboard.
Financial projections: an interactive example
Interested in seeing what a Causal model looks like? Here's a simple example model, which displays a cash flow projection for a company over the course of 12 months. Feel free to change the input variables listed at the top, to see how they affect the graphs below.
Once you're done looking at the model, click Use this template to customise the model to your own needs.