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Well-planned financial projections are a critical component of any business plan. They will help you make informed decisions about your business and give you a realistic idea of how much money you need and can expect to earn in the future. Financial projections are also critical if you are seeking funding from lenders or investors.
Your financial projections, which include your projected income statement, balance sheet, and cash flow statement, are based heavily on the assumptions you enter. For example, if you assume the average price for each unit you sell is $100, your predictions will be very different than if you assume an average price of $50. Likewise, assuming your payroll will grow at 5% per year versus 20% will dramatically affect your projections for years to come.
So how do you create the most realistic financial forecasts? The answer is to conduct proper research. Below are six key things to research to create the most realistic projections.
Related: 6 Ways to Make Financial Forecasting More Realistic
1. Research the size of your market
Clearly, you cannot predict that you will achieve revenue that exceeds the size of your market. Therefore, you should start by determining the size of your market. Most industry associations publish research on the size of their industry.
Where appropriate, you should multiply this size (which is usually done on a national basis) by the percentage of people living within a reasonable radius of your storefront to determine the size of your local market.
2. Research industry pricing
While you can certainly be the highest priced provider in your industry, you need to research competitive pricing to ensure your prices are reasonable. Start by identifying the top players in your market. Then visit their locations and/or websites to determine how they price their products and services.
Related: 8 Secrets to Reliable Startup Financial Forecasting
3. Research the gross profit margins in your industry
Gross margins are calculated as price minus cost of goods sold. It is the amount of money you have left over after subtracting the cost of goods sold from your revenue.
Especially for a startup, cost of goods sold can be difficult to accurately determine. But you can calculate them by researching the prices of the raw materials or components you need to produce your product or provide your services.
Additionally, you should look at the annual reports and 10-Ks of any public companies in your area. They will show the gross profit margins of these companies. The gross profit margins you use in your financial projections should generally not be significantly higher than this.
4. Research the wages you have to pay
An important line item on your income statement is the wages you have to pay your employees. To get an accurate estimate of this cost, you should research the current rates for the positions you need to fill.
You can find comparable salary rates online. See what other companies are paying for similar roles. For example, if you’re looking for an office manager, search for office manager jobs in your area and see what salaries other companies are paying.
Related: 4 Steps to Making Early Financial Forecasts
5. Research the cost to build and equip the space
Especially if you are starting a new business, you may need to factor the cost of website construction and equipment into your financial projections. This can be a significant cost, so it’s important to get accurate estimates.
You can search online to get estimates for new and/or used equipment that you will need to purchase. For design and construction, however, you should talk to local designers and contractors. Ask them to give you estimates so you can get a firm understanding of the exact costs you will incur.
6. Research potential growth rates
Even if you accurately estimate each of the above items, you can create wildly inaccurate financial projections if your growth rates are unrealistic. For example, assuming an average annual growth rate of 20% versus 5% will dramatically affect your projections for the coming years.
So how do you more accurately calculate growth rates? First, you should assess how growth rates affect other areas of your business. For example, if you need 2,000 square feet of space and 10 employees to serve 100 customers per day, what are the requirements to serve 500 employees per day? Will you need to open a second facility? Will you need to hire five times as many employees? If the answer is yes to both of these questions, that’s okay. But you should factor this into your financial model, as launching new facilities and hiring and training new employees takes time, both of which can slow down your growth plans.
The other way to estimate your growth rates is to evaluate larger companies within and related to your industry to see what their growth rates have been. While it’s possible you’ll be the fastest growing company ever, that’s unlikely. So get a good estimate of other companies’ growth rates and calculate your percentage within that range.
By conducting the proper research, you can be sure that your financial projections are as accurate as possible. This will give you the information you need to make sound business decisions and increase your chances of success. It will also give you credibility in the eyes of investors and lenders. They will appreciate your diligence and be more comfortable investing in your company.