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Well-crafted financial projections are a critical part of any business plan. They 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 when looking for financing from lenders or investors.
Your financial projections, including your projected income statement, balance sheet, and statement of cash flows, are based heavily on the assumptions you enter. For example, if you assume that the average price for each unit you sell is $100, your projections will be very different than if you assume an average price of $50. Likewise, assuming your payroll increases by 5% per year. will grow versus 20%, this will dramatically affect your projections in the coming years.
So, how do you create the most realistic financial projections? The answer is to do the right research. Below are the top six things to research to create the most realistic projections.
Related: 6 Ways to Make Financial Forecasting More Realistic
1. Research Your Market Size
Obviously, you cannot predict that you will earn revenues that exceed the size of your market. As such, you should start by determining the size of your market. Most industry associations publish research about the size of their industry.
If applicable, multiply that size (which is usually done on a national basis) by the percentage of people who live within a reasonable radius of your storefront to determine your local market size.
2. Industry Pricing
While you can certainly be the premium-priced provider in your industry, you should still research competitive pricing to make sure 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 Credible Startup Financial Projections
3. Research gross margins in your industry
Gross margins are calculated as price minus cost of goods sold. This is the amount left over after deducting the cost of goods sold from your income.
For a startup in particular, your cost of goods sold can be difficult to determine precisely. But you can estimate them by examining the prices of the raw materials or components you need to produce your product or provide your services.
In addition, you should check the annual reports and 10-Ks of all public companies in your space. They will show the gross margins of those companies. The gross margins you use in your financial projections should generally not be significantly higher than that.
4. Research the salaries you have to pay
An important item in your income statement is the salaries you have to pay to your employees. To get an accurate estimate of these costs, research the current rates for the positions you need to fill.
You can find comparable salary rates online. See what other companies pay for similar positions. For example, if you are looking for an office manager, search for office manager positions near you and see what salaries other companies pay.
Related: 4 Steps to Making Early Financial Projections
5. Investigate the cost of building out the site and equipment
Especially if you are starting a new business, you may need to factor in the cost of building a site and equipment in your financial projections. This can be a significant expense, so it’s important to get accurate estimates.
You can search online for estimates for new and/or used equipment to purchase. However, for design and build you need to contact local designers and contractors. Let them give you estimates so that you can get a good idea of the exact costs you will incur.
6. Research Potential Growth Rates
Even if you estimate each of the above items accurately, you can still make very flawed financial projections if your growth rates are unrealistic. For example, assuming an average annual growth rate of 20% versus 5% will drastically affect your projections in the coming years.
So, how do you most accurately estimate growth rates? For starters, you need to assess how growth rates affect other areas of your business. For example, if you need 2000 square feet of space and 10 employees to serve 100 customers per day, what are the requirements to serve 500 employees per day? Should you open a second facility? Should you hire five times as many employees? If the answer to both questions is “yes”, that’s fine. But you’ll need to factor that into your financial model, because 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 assess larger companies within and related to your industry to see what their growth rates have been. While it is possible that you will become the fastest growing company ever, it is unlikely. So make a good estimate of the growth rates of other companies and estimate your percentage within that range.
By conducting the right research, you can be sure that your financial projections are as accurate as possible. This gives you the information you need to make good decisions about your business and increase your chances of success. It also gives you credibility in the eyes of investors and lenders. They will appreciate your dedication and will be more comfortable investing in your business.