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How to Prepare Convincing Financial Projections

Photo credit: Journal of Accountancy

27th May, 2020

By Julius Masaba

Having a business idea is one thing. Executing it is another. Most times, you’re also advised to write down your idea before it vanishes, otherwise it will disappear like a spark of a light bulb. It’s also said that you need a plan on how you’re going to execute that idea.

A plan guides you and lets you identify the things you will need before you start executing the idea. It’s like a road map, a map for an unknown adventure. Ladies and gentlemen, am talking about a business plan. A business plan is needed otherwise you might start doing things, missing the bull’s eye and running around like a headless chicken.

A business plan must or is supposed to have certain key things, namely;

  1. About your company or startup (history, background, mission, objectives, location, etc.)
  2. Problem you’re solving (stating the rationale and justification)
  3. Product or service description (what you’re bringing to the market to solving the problem)
  4. Market/opportunity being exploited (intended size of your market share, etc.)
  5. Competition analysis (your competition under via SWOT analysis)
  6. Marketing strategy (marketing, customer acquisition and retention strategies)
  7. Team composition (who you will need to do what, with what skills/competences)
  8. Source of funds (how you will get the money, how you will use it)
  9. Financial projections (units, revenue, gross profit, expenses, EBITDA, tax, EAT, cash flow, etc.)

A business plan ought to be dynamic, the reason you need it in the beginning or when already operating. When you start executing it, you will need to amend or adjust it along the way. For instance if it’s for 5 years and probably need financing in the 3rd year, definitely it will need to be changed. It won’t be the same as it was in year 1.

Note that the above may not be exhaustive and the format could be different or change from one preparer to another. But the key content ought not to miss. So, today I want us to tackle something small, one aspect of a business plan – the financial projections or forecasts.

This is one of the things that give entrepreneurs or business people headache and sleepless nights, worse if he or she has no accounting or finance background. The least one can do is just download a template online, which at times he or she may not be conversant with or too complex. However, financial projections are simple to prepare if you just grasp the basics of production (or buying) and selling.

To the investors or lenders (who could be your source of funds), the financials are a complete turn-off if unconvincing, worse still if not impressive or neat. Trouble comes when you fail to explain the figures to them or to anyone (through a face-to-face pitch). So you should have key figures on your fingertips.

Financials should basically show you profit and loss (or income) statement or statement of comprehensive income and cashflow positions. A balance sheet, statement of changes in equity, etc. may not be relevant when starting out, because realistically speaking not much work or operations have taken place.

So the profit & loss statement should be your point of focus since you’re going to produce (or buy) and sell so as to establish whether you have made a profit or a loss (first) before any other statements follow.

Ideally, the profit & loss statement should show you;

  1. Sales/revenue/turnover
  2. Net sales
  3. Cost of sales
  4. Gross profit
  5. Other income (if any e.g. income as a commission)
  6. Operating expenses (e.g. rent, salaries/wages, staff meals, etc.)
  7. Profit/earnings before interest, tax & amortization (EBITDA)
  8. Interest (on borrowed funds) if any
  9. Tax (if any)
  10. Profit/earnings after interest & tax (EAT)
  11. Profitability growth (as a %)

Note that for cases where the business has been in operation and there is information or data, that past or historic information needs to be used to do the projections with applicable assumptions basing on internal and external (economy, industry or sector) metrics.

That said, the general economic outlook and most especially the markets you are entering or already operating in can be deceptive at times (or most times).

It doesn’t even matter the size and kind of business; whether it’s producing face masks, produce trading, ‘rolex’ (kikomando) making, and hardware distribution, making sanitizers or running a kiosk. The market may always fool you. The reason you need forecasts.

In fact, most businessmen and entrepreneurs would never be in business if they never sat down and made some projections of what they wanted to make or earn, spend at the end of the day. It’s the number that give the business idea sense and meaningfulness.

And most times when the idea looks ground breaking, most times the numbers will look sweet and trust me you will not want to turn away from the idea even for a moment, even when you have been shown a few setbacks or gaps in it.

Also, you never want someone to steal your idea, whoever might be watching your moves. The mistake we always make then is making the wrong projections and the action ends up backfiring, turning tumultuous in the long run.

Don’t be so ambitious

There is always a strong desire for optimism during forecasting of financial growth and the worst of all, relying on the market outlook thinking the results will be good. Trying to make the financials often ends up clashing with the part of our brain that is hardwired to desire certainty and precision.

In the end, it will have you preparing greedy figures or projections and unfortunately you will end up losing money. We become too ambitious to the extent that we end up building white elephants. To eliminate this trait, you need to consider two options and pick the most appropriate or convincing one before making your forecasts.

Top – Down Vs Bottom – Up Projections

The Top – Down is the most common among 21st century startup owners or entrepreneurs. Most time as a startup, an investor will ask you to show him your market share, which you have never even established. Very hard to establish especially here in Uganda where market capitalization statistics are vague (if available) or even non-existent.

So, the Top – Down forecast posits that you establish the size of the market you will need to serve and grow or be a leader in.

It says, assume you want to venture into Covid face mask making in Uganda, you project that ten percent (10%) of the population of about forty five (45) million people will purchase the special and innovative face masks in a given day, and this will translate into four million and five hundred thousand (4.5 million) face masks in a day.

In such a scenario, the projected numbers look impressive. The problem with this forecast though is that, the established 10%, because it can never be a truly conclusive figure to rely on. Remember that this is what most entrepreneurs are ‘forced’ to do yet they have not even had one year of solid business (in their funding pitches).

Getting to establish market size is a huge task yet the data may not be available or available but outdated. This can call for a whole year of research as you solidify your product or service. For a market like that you can easily be blindfolded in believing that fast growth will be easy to attain. Hell no!

For the Bottom – Up case, assume you have an automated sewing machine with a capacity of two thousand (2,000) face masks per day and you have five (5) day time sales persons, each selling four hundred (400) face masks every day from 8am to 5pm in a heavily populated town or along road with high human traffic.

Most likely between 50% and 70% will turn out to be cash purchases from passersby at the end of the day, and end up selling about two hundred (200) face masks – if we take 50% as the lowest conversion rate. You can therefore say the day’s revenue is UGX600,000, taking the selling price per mask to be UGX3,000.

Such a projection relying on real economic variables is thus more acceptable. Personally, one aspect with this option is that it will require some good marketing efforts and more displaying of the product, word-of-mouth, etc.

Also, basing on the production capacity per day, you will be able to establish the daily costs or expenditure, for example;

  1. Production costs (ingredients, etc.)
  2. Cost of sales incurred (commission paid to sales persons)
  3. Units of yaka (electricity) used (multiply daily units by rate per unit)
  4. Wages paid to the sales persons daily (till you make 30 days)
  5. Etc.

You can then be able to compute the relevant costs or expenses and deduct them from the revenue and gross profit at the end of the month. From there you can work it out further quarterly and then yearly, for the projections to make sense, then see how they will look like.

That said, I guess you can now easily pick what approach works best for you.

For any assistance or help regarding the above, feel free to consult me via WhatsApp +256789962775 or leave a comment at the bottom. Still you can leave an email in the ‘Contact Me’ page.

Stay safe!

NB: This article also appeared on Medium the same author. Click here

About the Writer

Julius Masaba is a private investment researcher and business consultant. He’s also the Business Development Lead at Ablestate, https://www.ablestate.org/  and a WordPress writer/blogger on startups, entrepreneurship, business and finance. He loves tech. Visit: https://consultmasaba.com/ 

2 thoughts on “How to Prepare Convincing Financial Projections

  1. Oh my God! I have loved your article and how articulate you are. I loved tour methods of projections and, surely, it is what we struggle with as entrepreneurs. And I have taken your advise of using the real dynamic market scenarios. I have been doing that but with no emphasis from a consultant like you. You article is well punctuated, articulate and easy to understand. If we can have such consultants in Uganda, then we have hope. Thank you. I will be visiting your blog a lot.

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