Financial Projection

Updated on May 10, 2024
Article byRishab Nigam
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Financial Projection?

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.

Financial Projection

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Financial Projection (wallstreetmojo.com)

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.

Financial Projection Explained

The process of financial projection in business plan explains the estimates and the future forecasts made regarding the business’s financial condition and performance during a particular period. It may be for the coming year or the next few financial years. These estimates and projections are calculated based on some factors like past performance of the business, the current economic conditions, the market volatility, the demand, and supply of the products and services.

These financial projection statement give the analysts and investors an idea about the anticipated revenue and expenditure of the company, the cash flows, the estimated profits and future potential regarding growth opportunity and expansion. This helps them in making informed financial decisions about whether to invest in this company or not.

Even the lenders can assess the financial condition and growth opportunity of the entity and them decide whether it is worthwhile to lend money to this venture and the level of risk involved in the process. The data regarding financial projection helps in assessing the credit worthiness of the company.

How To Make A Financial Projection?

The process should be based on well supported and realistic facts and figures after accounting for the condition of the market, the current trends of the particular sector or industry, the past data and the requirements and condition of the business.

The determination of the right financial projection in business plan 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. It helps 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.

Financial projection statement gives management a concise idea and image of how the company would perform. However, merely preparing the projection is not enough for the entire process. It is equally important to regularly review and update the projections as per the changes in the factors on which it depends, so that the entire financial system of the business is accurate and relevant.

Example

Let us take the example of the Income Statement of ABC Company. It is anticipated that the revenues 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: –

Example 1

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 expenses as 15 percent of the sales or the revenue estimates.

Step #5 – Determine earnings before interest and taxes 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 income 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 taxes. 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: –

Financial Projection Example 1.1

The following would be the projected income statement: –

Financial Projection Example 1.2

Elements

The financial projections for startups or for big companies 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 statements, 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 sheet 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 liabilities. 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.

Importance

  • The financial projections for startups or for big companies 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 statements, 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 operations 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.

Financial Projection Vs Financial Forecast

The above two terms are commonly used in the financial world. Let us understand the differences between them.

  • The financial projection report is a financial estimate or prediction of the performance over a period of time and the latter is just the prediction of the company’s financial performance.
  • The former is more towards a longer-term approach whereas the latter is a short term approach.
  • The former estimates the revenue, profits, cash flows of a few years, whereas the latter estimates the capital requirements for daily operations of the business.
  • The former is used for budgeting, making future financial plans and investments, whereas the latter is used for fundraising or business expansion.

However, both the terms are closely related to assessing the future financial performance and its interpretation depends on the context and the type of organization.

Recommended Articles

This has been a guide to what is Financial Projection. We explain it with example, how to make it, its differences with financial forecast & importance. You may learn more about financing from the following articles –