Investors, lenders, and even friends and family are going to want to see your financial projections before they put a dime into your startup. Creating realistic, data based financial projections for a startup can be difficult, especially when your idea is new, with little history of success to build your projections. There are 3 basic steps to create financial projections that are more than just your “gut” feeling.
1. Supply and Demand Research – The first step in creating realistic financial projections is to understand your market. Does anyone actually want your product or service? Then, can you compete with those who already offer your product or service? A great tool to conduct basic market research is the Google Keyword Planner. This tool allows you to type in a keyword phrase and find the monthly search volume on Google for that keyword. For example, let’s say you have an amazing new dandelion plucker tool that allows you to pluck dandelions from your yard without killing your back, using the Google Keyword Planner you can find that there are only 140 monthly searches in the US for “dandelion tool” and 70 monthly searches for “dandelion picker.” This research tells you a couple of things. First, there are not millions of people looking for a tool like this already, or at least they are not looking for the tool online. Secondly, it tells you that online sales of a product like this may be limited. You may need to build projections based on getting into retail stores with your product.
Finally, you should look at the other tools on the market. What is their price point? Can you compete? Or is your tool so much more innovative that you can charge a higher price than your competitors?
2. Building Assumptions – The next step is to use the data you gathered in the research phase to build a set of sales, pricing, and expense assumptions for your product or service. For our dandelion tool example, here are several assumptions that you would need to develop and work into your projections:
- Retail price
- Wholesale price
- Monthly sales volume
- Growth rate
- Quantity discounts
- Manufacturing costs
- Sales commission costs
You will need to develop all of these assumptions and more to build your model. You want to use assumptions so that you can quickly and easily change one input like price and have the entire projection immediately reflect that change.
3. Financial Statement Creation – Now that you have built a number of assumptions, you need to take those assumptions and use them to build a full set of financial projections. You don’t need to have a PhD in spreadsheet modeling, but your income statement should be properly formatted (revenue on top, expenses on the bottom), your cash flow statement should accurately show the difference between profits and cash flow, and your balance sheet should actually balance! Getting your projection information into a standard format can be a challenge. There are a couple tools to help you including ProjectionHub which is a web app that helps entrepreneurs create financial projections, and there are also a number of free Excel templates that can be useful as well. Creating financial statements that all tie together, and that can be easily manipulated by changing assumptions can be difficult to build on your own, but most lenders and investors will demand such a model.
Although Mom and Dad may fund your dream on a gut feeling, sophisticated lenders and investors will not. You need to develop your projections based on research, reasonable assumptions, and the projected financial statements should actually look like… financial statements! If you can follow these three steps you will be well on your way toward realistic projections and a successful startup.