Startup Basics: Four Tips for Creating Realistic Financial Projections
One of the most important components of your startup's business plan is its financial projections. These projections are incredibly influential in lettings investors know that you have taken the initial planning steps of your startup idea seriously, especially if they're laid out in a clear, logical manner. However, it's tricky to create these projections when you aren't bringing in much or any revenue, and at times can feel like complete fiction. So, how exactly do you create realistic, actionable financial projections? This article describes five tips for not only getting these projections written down but also getting them written in a way that will convince investors you mean business.
1. Include monthly cash-flow projections
If you're an early-stage startup, one of the biggest worries that investors will have is your cash flow. Though it's well-known that most startups will burn through cash early on, it's important to demonstrate to investors that you know exactly how much money you're spending each month and how you're getting that money. Make sure you calculate and present a monthly cash-flow estimate for at least the first year of your business. You'll likely want to calculate this for the first three or five years of work, but keep those extra two or four years of projections to the side unless investors specifically ask to see them.
2. Make sure your financial ratios stay within industry expectations
One of the biggest pet peeves of those looking to invest substantial amounts of money in a business is incorrect financial ratios and profit margins. For example, if you're running a local restaurant and you've drafted a business planning saying that you expect a 30 percent profit margin, investors will instantly write off your entire plan. That's because the restaurant average profit margin is between 3-5 percent, showing that you have unrealistic expectations or are not willing to look at the business with an objective viewpoint. If you've run all of the calculations and you're stilling ending up with a high profit margin, then it is more than likely you have an unrealistic expectation somewhere that investors are likely to catch.
3. Don't ignore traditional segments of a business without evidence-backed reasons
A critical mistake many startup founders make when drafting a business plan is the omitting important business actions that cost money. One of the most common segments to omit is a marketing budget that includes print media, online advertising, pictures and video, and more. When prompted on these missing aspects, founders will likely not have a true reason for omission other than to make the financial projections look more appealing. This will not please investors, leading them to devalue other parts of your business plan or lose confidence in you entirely. It's better to include reasonable budgets for these parts of the business. If you truly believe they're unnecessary, then explicitly state why you believe this to help investors understand.
4. Show the investors an enticing return on investment
Most investors aren't putting money into your business because they believe in ideas. They're investing in your business to generate a high return, and are usually expecting an amount at least ten times their initial monetary input. To show investors an impressive return, you should, at the minimum, include a statement that informs investors how they'll get this return. That statement could range from an initial public offering with a projected share price and company valuation to acquisition from a larger company in your sector. Take some time to think about what the most realistic method for investor returns is, then describe it clearly and concisely.
Creating a set of reasonable financial projections is quite difficult, but is doable with enough iterations and objective viewpoints. Make sure you have friends, co-founders and others in the startup world you trust take a look at your business plan's projections before you start taking them to investors. This way, you'll get fresh eyes on the contents that may help you restate parts you thought were clear or help you include segments you thought weren't needed. With these tips and some time spent laying out your projections in a logical and aesthetically pleasing fashion, you'll be sure to impress future investors.
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CFO Masters is a network of select fractional, interim, part-time, and temporary Chief Financial Officers, strategically positioned to focus on growing and transforming businesses on as-needed, on-demand basis. Founded in 2016, CFO Masters offers an affordable alternative to hiring a full-time CFO that can make a big impact on your business. For more information, please visit CFO Masters.