This week our Valuation Academy will focus on a very specific topic: financial projections. In our previous posts (Why & when of valuationQualitative startup attributesBusiness angels’ valuation methods) we have discussed the price of a company from different perspectives in an attempt to give you a good general understanding, and now it’s time to devote our course to the financial aspects.

In this post our aim is to instruct you on the importance of forecasts, while in the next post we will dive into the projecting, giving guidelines and useful tools for entrepreneurs.

What is financial forecasting?

Financial forecasting refers to the process of estimating the future performance of a company-more specifically, its future revenues and costs.

That said, it’s easy to understand this estimation process sets the entrepreneurs in front of a daunting task. Forecasting the future revenues is hell of a job for mature companies, how can that be reasonably easier for companies facing daily uncertainty? More importantly, does this matter?

Yes, it does and yes, it’s difficult. But by personal experience, making the projections of your company is of great help to your fund-raising activity, and to you, the entrepreneur.

If you are struggling with financial projections, check this Financial Projections Template – an Excel spreadsheet that constitutes a strong base for your startup projections. You can use it right away!

Present & future business model

Let’s put it this way: you realize your company has a big potential. You have something unique with disrupting power. I may ask you: how are you going to make money out of it?

If you answer is “something good will come up”, then take my advice and try to figure out a viable business model and then, project it to the future. It may be likely you need more than a brainstorming session before you find a valid selling approach. What may look good in the short term is not necessarily feasible in the long run, and projecting it from today to tomorrow is the only way to find out. You may find out the business model has a high working capital which may not be sustainable, a decreasing operating margin (% growth revenues < % growth costs) or that it’s simply not replicable.

On the other hand, let’s assume you have a proven business model which is already yielding good results. Projecting that to the future will be crucial in determining the need of resources necessary to its support – that is, if you need additional external capital or if it’s self-financed and, in addition, if the projected growth is up to investors’ expectations.

Pay attention to assumptions

Furthermore, projecting the future performance, especially when it comes to revenues, is subject to a set of assumptions, which needs to be taken into serious consideration throughout the development of the business: only identifying them upfront will let you find the “break-even” points and thus promptly react whenever the current performance falls bellows such indicators. For example, if you assume your marketing activity will need to reach a conversion rate audience to customers of at least 5% to break-even, then you will be much more reactive in adjusting your marketing if the observed conversion is below compared to an entrepreneur who has no clue.

In other terms, financial forecasting puts you in front of a mirror: where do I stand and where do I want to be in the future? This is not a waste of time: it’s the only reasonable way to determine a clear path to success. The projected revenues and costs shall be perceived as the proof that a thought-through execution plan has been determined rather than as a game of best guessing.

To investors, projections matter especially in this regard. They won’t look at the decimals, so to speak, but rather at the process underlying them and at the expected need of resources. In the next post we will dive more into the projecting, giving guidelines and useful tools for entrepreneurs. Stay tuned on our blog!