September 1, 2020

How to Build Accurate Financial Projections

Financial projections let you communicate the future of your business in numbers. They help investors and other stakeholders understand where your business is going.

By
Mack Grenfell

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:

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:

Expenses can be further split into:

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:

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:

Historical data

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.

Clear assumptions

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.

Scenario planning

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:

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.

While you're here...
If you enjoyed this post, then you might also like our product — Causal. It's a new way to build models, visualise data, and communicate with numbers. Click here to learn more.