Financial Projection Definition
The financial projection shows forecasts and predictions on the financial estimates and numbers that range from revenues and expenses pertaining to financial statements and takes external market factors and internal data into account.
- The determination of the right financial projection depends on external factors, namely economic conditions and market sentiments.
- The internal factors that are inculcated into the projection are the current business position and available historical data that is utilized to derive consistency.
- Help the stakeholders provide comprehensive estimates of chosen line items.
- Generally, they are formed as part of the executive summary.
- These statements can be described as forward-looking statements.
- It gives management a concise idea and image of how the company would perform.
How to make a Financial Projection?
Let us take the example of the Income Statement of ABC Company. It is anticipated that the revenuesRevenuesRevenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions. are going to increase by 25 percent from the base year revenues. The cost of sales for the projected income statement would be 65 percent of projected sales.
The operating expense amounted to 15 percent of the sales generated by the business, and the interest expense amounted to be the same as compared to the base year income statement. The interest expense for the base year was reported at $2,000. The business is taxed at a rate of 25 percent. Help the management prepare a projection on the income statement. The base year income statement is as follows: –
Prepare the Projected Income statement as displayed below: –
Step #1 – Initialize the revenue estimates, asset position, liabilities position, and base it on the revenues or the current asset size of the business. In the above example, revenue estimates increase by 25 percent for the base year.
Step #2 – Baseline the cost of sales, basis the revenue estimates determined above, and as shown in the example below.
Step #3 – Calculate the gross profit as the difference in revenues and cost of sales.
Step #4 – Determine the operating expensesOperating ExpensesOperating expense (OPEX) is the cost incurred in the normal course of business and does not include expenses directly related to product manufacturing or service delivery. Therefore, they are readily available in the income statement and help to determine the net profit. as 15 percent of the sales or the revenue estimates.
Step #5 – Determine earnings before interest and taxesEarnings Before Interest And TaxesEarnings before interest and tax (EBIT) refers to the company's operating profit that is acquired after deducting all the expenses except the interest and tax expenses from the revenue. It denotes the organization's profit from business operations while excluding all taxes and costs of capital. by taking up a difference between gross profit determined in step 3 and operating expenses at step 4.
Step #6 – Deduct the base-lined interest incomeInterest IncomeInterest Income is the amount of revenue generated by interest-yielding investments like certificates of deposit, savings accounts, or other investments & it is reported in the Company’s income statement. as assumed from the prior year from the results of step 5 to arrive at the earnings before taxes.
Step #7 – Deduct the taxes from the earnings before taxes to arrive at the profit after taxesProfit After TaxesProfit After Tax is the revenue left after deducting the business expenses and tax liabilities. This profit is reflected in the Profit & Loss statement of the business.. The tariffs are determined as the 25 percent of revenues before taxes, as defined in step 6.
The following shows the calculation on the income statement as shown below: –
The following would be the projected income statement: –
Elements of Financial Projects
The financial projection can be termed as a summarized financial model. It could be based on assumptions and estimates, as well as growth functions. A node can comprise of the income statementsIncome StatementsThe income statement is one of the company's financial reports that summarizes all of the company's revenues and expenses over time in order to determine the company's profit or loss and measure its business activity over time based on user requirements., cash flow projections, and balance sheet projections.
#1 – Income Statements
The income statement usually comprises of estimates and projections on revenue and expenses along with net income.
#2 – Cash Flow Projections
The cash flow projection usually comprises of revenues collected in cash form—the disbursements of cash display all the expenses incurred by the business on a cash basis.
#3 – Balance Sheet Projections
The balance sheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company. projects or describes the net worth of the business. Projections can be prepared for the assets, equity, and liabilities of the balance sheet. Assets represent items that are of economic value and importance for the business. Liabilities represent items that the company owes to the creditors.
Equity is generally determined as the difference between the assets and liabilitiesDifference Between The Assets And LiabilitiesWhat makes Assets & Liabilities different is that while the former refers to anything that a Company owns to gain long-term economic benefits, the latter refers to anything that the Company owes to other parties. . The expenses present in the income statement can be based on the percentage of revenues. The taxes can be assumed as the rate prescribed by the government. The assets and liabilities of certain types can also be based on the prior year asset position or last year’s sales achieved by the business.
- The financial projection is a concise financial model. Helps in the determination and planning of the requirements of working capital for the success of the business operations.
- The projection is one of the essential inputs utilized in the preparation of Strengths, weakness, opportunities, and threat analysis. It is also a supplemental report used for industry analysis.
- In the absence of the actual financial statementsFinancial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels., projections can be shared by the business to their stakeholders and creditors.
- Doing so ensures retention in investor confidence and helps businesses getting new investments for their latest projects. The financial targets are metrics that the company has to meet for success and survival in the competitive environment and industry.
- The financial projections allow the top management to detect early warning signs for business performance and enable a business to catch potential deviations.
- It helps prepare the budget for different departments and business units working under a more prominent organization.
- It gives a clear picture of the management of how the company is going to perform.
- Projections help in making strategic decisions on business operationsBusiness OperationsBusiness operations refer to all those activities that the employees undertake within an organizational setup daily to produce goods and services for accomplishing the company's goals like profit generation. and growth.
- The financial projections become reference statements along with available financial statements for the lenders and creditors.
- The lenders and creditors take the projection into account as a basis for making further investment decisions towards a basis.
- It helps the management establish targets and establish early warning signs related to business performance.
- It provides summarized information to the stakeholder in the absence of financial statements. If they wish, they can ask the business to present detailed financial projections to see whether the company intends to meet its business targets.
The financial projections are a decision-making tool for the management and creditors. It is a concise financial model that shows forecasts basis the estimates as determined by the administration itself. It may be used by lenders and creditors to base their investment decisions.
This has been a guide to Financial Projection and its definition. Here we discuss how to do step by step financial projection along with importance and benefits. You may learn more about financing from the following articles –