How to create financial projections for business plan

The financial of a business plan is one area where entrepreneurs face challenges in a business plan. In this blog, apart from broadly describing the key elements of a financial projection template, I will also share a few formulas that will help users to calculate NPV and few financial ratios.

The financials are derived based upon industry facts and our best assumptions. The financial projections are created for a period of 3 years and in some cases for 5 years. The key components of the financial plan are:

·         Revenue Statements – Every Business has a unique business model and deriving the revenue statements is an art as much is it science. For example a restaurant business model can be derived by calculating the number of customers that will visit the restaurant and the average amount that they will spend on the food. On the other hand if it is something as complex as an air ambulance service, then factors like patients flown, average hours, services provided and multiple other factors can come into play. So, every business model is different and it is indeed an art to map these business models correctly in the revenue statements.

·         Expenditure Statement – The expenditure statement comprises of operational expenditure like salary, rent, utilities etc. The capital expenditure is shown as a negative item in the cash flow statement.

·         Income Statement/PL Statement – The income statement or PL statement draws the overall income of the company by summing up the income lines and deducting the expenditure from the revenue. It can be a positive or negative figure depending upon whether the company is in a loss or at a profit. The income statement also shows the Gross Profit (Income minus the direct costs), Earnings Before Taxes (EBT) and Net Income (Income after deducting the applicable taxes).

·         Balance Sheet – The balance sheet displays the Asset and Liability of the company and is driven by the fundamental premise that Asset equals Liability plus the Total Shareholders Equity ( Share Capital plus retained Earnings) of the company. Typical asset items include cash and cash equivalents, Inventories, Accounts receivables etc. Liabilities on the other hand include accounts payable, debt, accrued expenses etc. The balance sheet is taken as an indicator of the financial health of the company.

·         Cash Flow Statement – The cash flow statement as the name says gives a clear month-on-month idea of how much cash balance remains in the company’s accounts. It is generally depicted in the Annual Reports on a Year-on-Year basis but for internal use businesses can maintain a month-on-month cash flow statement. The cash-flow statement gives a clear picture because it takes into account the amount of cash that has already been received into the company’s account.

Once these fundamental statements are derived there are different ratios and values that financial analysts can derive to get a better understanding of the current and future financial health of the company. In this post we are going to discuss about how we can do NPV calculation.

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In the NPV calculations as shown above, the cash flow after taxes is considered for calculation of the present value factor, which is denoted by the formula 1/(1+r)^n. In this calculation we have considered the rate as 10% and the NPV is calculated for an overall period of 5 years.

There are several ratios that we consider after doing the financials. These are Return on Equity (Net Profit/Share Capital), Capital Turnover Ratio (Total Revenue/Total Capital Expense), Gross Profit Ratio (Gross Profit/Total Revenues) etc. There are several other formulas that are used to check the financial viability of a business. There can be different set of parameters that are used for measuring different types of businesses.

The best way to do is to use standard financial projection templates which has been developed and fine-tuned in-house to suit the work requirements of the team. This is the way that I find convenient since these templates have been refined over time while forecasting different business models. You can quickly make the necessary changes and complete the financial forecasts quickly and correctly. For existing businesses it is important that forecasting is tied to the financial statements of the previous years and validated by the company’s auditors. This gives a high degree of confidence that the forecasts done are in-line with the historical business benchmarks into the next 3-5 years.