Are you wondering what are the reasons why entrepreneurs need financial projections?
Some entrepreneurs love math and juggling numbers to create new business plans. Others are far more passionate about the product, sales and just doing the business. Whatever your strengths and interests, it is vital to layout financial projections in advance.
Here are just some of the reasons you need them, and how they can help.
Validate this is actually a viable business
Unless you’ve run financial projections you really don’t know if this is a viable business idea.
You need a financial model to layout profit margins, and see if they are sustainable. You need to analyze fixed versus variable costs, and what that means for viability which is one of the big reasons why entrepreneurs need financial projections.
You want to know if it even has the potential to deliver enough reward for your effort. As well as warrant the participation of anyone else you may need on board to make this happen.
Assess pricing models and strategies
You can have a lot of fluffy ideals and assumptions when you begin incubating a new business idea. The financial projections are where you really hone this idea as a true business.
A part of building these projections is establishing potential pricing. A lot can be revealed in this process. Such as where you really need to be in order to make a profit, reach scale, and hit a point of sustainability.
This will show you the impacts and likely outcomes of freemium style pricing models, or at the other end of the spectrum, focusing only on high-end niche clients.
Calculate how big this business can be
Keep in mind when wondering about the reasons why entrepreneurs need financial projections, that this process of financial forecasts will help clarify how big this business can really become.
You may be focusing on the next 12 to 60 months in initial projections. Yet, you’ll also be doing the research and math on the size of the market, addressable market and market share.
Being an entrepreneur can be a lot of work, as is any job. If you are going to put in the work, you might as well make sure you are getting really big rewards for it. For the same amount of hours in a day you can build a $100k career or a $1B plus startup. Which results would you prefer?
A lot of your other plans are going to depend on how big this business can be too. It will impact the overhead you can take on, the marketing budget you can have, who you can afford to recruit, and whether you can raise VC money or not.
Identify cash flow gaps
One of the biggest threats to startups is the cash-flow gap.
You can have huge potential. You might even be able to get started with a very lean, bootstrapped startup approach. However, your best month can often become your hardest month, with the most risk of going bankrupt.
There is often going to be a point where you run out of your seed capital, and have a huge amount of orders. Yet, you need to be able to cover the cash flow needs between this gap to make it through.
How much do you need and when? Key question to ask yourself when thinking about the reasons why entrepreneurs need financial projections.
Identify funding needs
Once you know the above, you can properly assess your needs for startup fundraising. This is obviously one of the main reasons why entrepreneurs need financial projections.
How much will you need to get to profitability, to bridge the gap, get to the next milestone and round?
Depending on where this need falls and how much, you can determine the best types of financing for your company. This may be upfront seed funding from angel investors, personal credit, factoring loans, VC funding, or direct equipment financing or real estate loans.
Remember that storytelling plays a key role in fundraising and you will need capital to scale things up. This is being able to capture the essence of the business in 15 to 20 slides. For a winning deck, 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.
Remember to unlock the pitch deck template that is being used by founders around the world to raise millions below.
Identify Areas For Business Cost Cutting
Whether you are completing these financial projections in advance of starting a business, or are recasting your finances in the face of economic changes, this is also a tool for identifying areas for cutting business costs.
You may realize that you need to completely change your idea for infrastructure, organization and production to make things work. Physical offices and retail outlets may not make sense anymore. You may have to find ways to drive down both static and variable costs.
Give investors insights on potential returns
Entrepreneurs need financial projections to forecast potential valuations and returns for investors. You must be able to give them some idea of what their investment can yield. As well as being sure you can comfortably take on new debt or equity partners without completely sabotaging the viability of this business or the excitement you have to continue with it.
To complete business plans and pitch decks
Financial projections are a core part of fundraising pitch decks and business plans. You can’t really complete these documents and assets without the math.
When you do include financial projections in these documents, expect them to be one of the biggest focuses of those you share them with. They want to make sure you know what you are doing, and what the potential is.
Below you will be able to find a video where I cover in detail how to create a pitch deck.
Financial projections give you sales, revenue and profit goals to shoot for.
You’ve got to have goals if you are going to keep on improving. You also need these goals to share with your teams, so that they know what they are working towards.
If they don’t know the goals and milestones, they cannot effectively help you get there. This can be one of the biggest mistakes entrepreneurs make. Though, when you get this right, it can make a dramatic difference in the effectiveness and output of your teams.
Hopefully, this post provided some perspective as you are thinking about the reasons why entrepreneurs need financial projections.