How to read financial projections? When you have a good financial projection it can show you if the business has enough money coming in to support itself. There are several things that can be learned from reading the financial projection if it has been prepared correctly.
In this article, we will look at what is included within a company’s financial projections, what they mean, and show you how you can read your financial projections to help you get a clear picture of your company’s projected income, future performance, and risks.
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Here is the content that we will cover in this post. Let’s get started.
- 1. What’s Included in a Company’s Financial Projections
- 2. Cashflow statement
- 3. Income statement
- 4. A balance sheet
- 5. How to Read Financial Projections
- 6. How to read a cash flow statement
- 7. Cash from financial activities
- 8. Cash from investing activities
- 9. Cash from operations
- 10. How to read an income statement
- 11. Reading a single-step income statement
- 12. Reading a multi-step income statement
- 13. How to read a balance sheet
- 14. Current assets
- 15. Current liabilities
- 16. Conclusion
What’s Included in a Company’s Financial Projections
A company’s financial projections can be used to show the impact of a proposed business decision on a company’s future cash flow and profitability. These projections are usually provided in three forms:
- Cash flow statement
- An income statement
- A balance sheet
Let’s take a look at one in a little more detail:
A cash flow statement shows the company’s cash inflows and outflows. In order to understand this statement, you need to know that there are three kinds of cash flow: operating, investment and financing. Operating cash flow is the amount of money a company takes in from selling products or services, investment cash flow is the amount of money a company spends on new assets, and financing cash flow is the cash from investors such as shareholders and banks.
An income statement is a financial report that shows how much money your business has made during a period of time. It’s also known as a profit and loss statement (P&L). Income statements show your company’s revenue, expenses, and net income for a given period of time. You can use them to calculate your company’s revenue and gross margin over time. You can also use an income statement to compare your company’s performance against competitors in the same industry or to track how well you’re managing costs versus revenue growth over time.
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A balance sheet
A balance sheet is a financial statement that shows the liabilities, assets, and net value of a business at any moment in time. It shows how much money the company owes to others (liabilities), how much it owns (assets), and how much is left over for the owners (net worth). The balance sheet is separated into two halves: current assets and current liabilities. Current assets are things like cash, and accounts receivable. Current liabilities are things like accounts payable (money you owe), taxes, overdrafts, etc.
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How to Read Financial Projections
Now that you have a firm understanding of what a company’s financial projections consist of, let’s dive in and show you how you can read each of these financial statements to help you to better understand your company’s finances.
How to read a cash flow statement
The cash flow statement (also known as statements of cash flow) shows the flow of cash and cash equivalents during the period under report and breaks the analysis down to operating, investing, and financing activities. It helps in assessing the liquidity and solvency of a company and to check efficient cash management.
As explained earlier, there are three key components of a cash flow statement.
Cash from financial activities
This activity includes cash injections from investors such as shareholders and banks, new share offerings, and so on, as well as cash outflows to shareholders when the company generates profits. They represent the change in the business’s capital and borrowings.
Cash from investing activities
This category includes all cash inflows and outflows related to investments made by the company during a specific time period, such as the purchase of new plant, property, equipment, improvements, capital expenditures, and cash used to purchase other investments or businesses.
Cash from operations
This covers all cash inflows and outflows created by an enterprise’s revenue-generating activities such as the sale and purchase of raw materials, items, labor costs, inventory buildup, advertising, and delivering the product.
The combination of these three changes will indicate the overall rise or reduction of cash and cash equivalents throughout the time period. When the sum of the changes is added to the cash and cash equivalents at the start of the period, it will show the cash and cash equivalents at the end of that same period.
Tips for reading a cash flow statement:
Look for a few key metrics when reading a cash flow statement: asset sales, income earned, and investments in business development. The change in total cash flow from previous periods reflects your company’s capacity to break even using liquid assets. Take note of how your company allocates revenue to various departments and initiatives.
How to read an income statement
An income statement can come in two different formats, single-step and multi-step:
Reading a single-step income statement
A single-step income statement is the simplest and most common form of an income statement.
The single-step income statement shows the gross profit, operating expenses, and net income for a company, along with its assets and liabilities.
Simply put, a single-step income statement will show:
- The business name, income statement title, and time period.
- All revenue and gains are in one group.
- All expenses/losses in one group.
- Total income or loss for that period (Subtracting expenses and losses from revenue and gains)
The gross profit is found by subtracting the cost of goods sold from sales revenues. The operating expenses are listed as a single line item on the financial statement, representing all expenses incurred during the reporting period.
The net income is worked out by subtracting operating expenses from gross profit, with any gains or losses from other sources being recorded as other income or expense items in the appropriate section at the bottom of the page. When you read financial projections, you’ll understand how that works.
Reading a multi-step income statement
Many businesses, especially larger ones, often use a multi-step format income statement because it provides more detail and information for making business decisions. A multi-step income statement separates nonoperating revenues and expenses from operating revenues and expenses.
A multi-step income statement will show:
- The business name, income statement title, and time period.
- Gross profit [Subtracting the COGS (cost of goods sold) from net sales]
- A list of operating costs (which you subtract from gross profit to determine operating income).
- A list of nonoperating expenses and revenues, (which you combine with the operating income to calculate total income or losses)
The most extensive format of income statements is a multi-step income statement. It starts with net sales, which is the difference between gross sales and returns, discounts, and allowances for damaged or defective merchandise. Gross profit is then calculated by subtracting COGS from net sales.
Operating expenses are deducted from gross profit to find operating income before taxes. The operating income is then taxed at the company’s tax rate, which reduces its net income.
Tips for reading an income statement
The net income after tax is the most important statistic on an income statement. This metric is used by investors and banks to forecast your company’s financial performance. Analyze your income statement by emphasizing the figures that account for the majority of your net income and how to either decrease associated costs or invest in profitable areas.
How to read a balance sheet
Your balance sheet (sometimes called a statement of financial position) provides a snapshot of your practice’s financial status at a particular point in time. As mentioned earlier, the balance sheet is divided into two sections, current assets, and current liabilities. You’ll see how that works when learning how to read financial projections.
A current asset is an asset that can be converted into cash within one year. The most common current assets are cash and short-term investments, such as treasury bills and corporate bonds.
Other forms of current assets can include (but are not limited to):
- Cash in the bank
- Checking accounts
- Savings accounts
- Money market funds
- Certificates of deposit
- Mutual funds
The current liabilities section of a financial statement is where you’ll find all the money your business owes to outside parties. This includes things like accounts payable, accrued expenses, and short-term debts.
Other forms of current liabilities can include (but are not limited to):
- Customer prepayments
- Current portion of long-term debt
- Bank Account Overdrafts.
- Dividend Payable
- Unearned Revenue
According to the balance sheet formula, the sum of liabilities and owner’s equity equals the total assets of the company.
“Liabilities + Owner’s Equity = Total Assets”
Tips for reading a balance sheet
When reviewing a balance sheet, compare the figures in each column to generate ratios for evaluating financial stability. Examine your company’s liability-to-asset ratio to determine its worth and performance. Having much more assets than liabilities signifies financial independence and the possibility for development.
Knowing how to read financial projections can come in handy when you’re preparing a pitch deck. You’ll know how potential investors will view the financials, and you can design a compelling narrative accordingly. Keep in mind that in fundraising, storytelling is everything. In this regard, for a winning pitch deck to help you here, take a look at the template created by Silicon Valley legend, Peter Thiel (see it here) that I recently covered. Thiel was the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash.
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In conclusion, while the language of accounting may be intimidating, the analysis behind it is not. Financial projections are essentially a form of forecasting, which is essentially a way of attempting to predict the future.
This can be a tricky thing to do, no matter who’s doing the predicting. However, the trickiest part for a small business owner or entrepreneur is in understanding how to read financial projections.
That’s because there are many different ways to portray data, and each of those ways has its own benefits and drawbacks.
Hopefully, this article has been helpful for demystifying financial statements and has given you a better understanding of how to read them effectively.
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