When a startup is in its initial phases, nothing is certain. Many aspects beyond a founder’s control influence the startup’s narrative. That’s why startups must focus on building a solid foundation when they’re starting.
And financial reporting and forecasts should be the first things they should focus on. Why? Because they can provide a clear picture of a startup’s financial health and come in handy when investors and stakeholders want to see evidence the startup is financially viable.
However, it is challenging to predict how the future will look for a startup, which makes it important to work with accountants for startups to understand all the underlying financial implications. Let’s talk about how you can create a financial forecast for your startup.
What Is Financial Forecasting?
Financial forecasting gives insights into a startup’s future income and outgoings. It facilitates decision-making relevant to optimal performance and includes analyzing a company’s historical data and identifying trends to make accurate future projections.
As part of these projections, startups simulate and analyze the potential financial outcomes that could arise from hypothetical scenarios, such as a merger or initial public offering (IPO). Depending on a startup’s chosen approach, they can build financial projections based on their relevant industry and market.
Reasons for Financial Forecasting
Financial forecasting is cumbersome, so why should startups do something so complex and time-consuming? Let’s look at some reasons why:
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Help Build a Business Strategy
Financial projections lay the foundation for a startup’s business strategy. Suppose the foundation isn’t laid on sound financial projections. In that case, startup owners can end up making decisions that incur more expenses than revenue, ultimately causing the startup to run out of cash.
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Secure Funding
Financial projections highlight startups’ opportunities to generate enough profit and excel. These insights help potential investors understand whether they should or shouldn’t invest in the startup, making these projections a crucial part of any fundraising pitch.
Steps to Creating Financial Forecasts
When creating a financial forecast for a startup, it’s essential to include important documents, including a balance sheet, cash flow statement, and income statement. They help investors understand how a startup will repay loans and what it intends to do with the money they get.
Let’s find out how a startup can effectively create financial projections for their business and forecast:
1. Project Sales
Startups need to have a robust business plan coupled with key expenses to visualize how much money they need to launch and the subsequent costs they’ll need to cover.
Creating a sales forecast and using it to project anticipated monthly revenues and profits is also necessary.
2. Create an Expenses Budget
An expenses budget is how much a startup anticipates spending during the first five years of operation. It includes all overhead and operating expenses the startup expects during its operations.
It’s wise for startups to break down their startup expenses by variable and fixed costs. Variable costs depend on demand and sales, while fixed costs include expenses like payroll and bills. Breaking down these costs helps to budget better and improve their profitability.
3. Build Financial Projections
Startups can plug their expenses and revenues into a cash flow projection that displays monthly inflows and outflows of money for the initial 12 months of operation. For subsequent years, projections can be made quarterly or yearly.
Financial projections can be created using tools like spreadsheets or accounting software.
4. Project a Break-even Point
The expenses budget and project sales forecast show a startup’s profitability. The break-even is when the startup starts seeing some profit, which means it’ll bring in more money than spent.
For a startup to see real profit, giving time is important. Few businesses see profit in the first year. Nonetheless, investors will be interested in how a startup will reach a break-even point, making it important to come up with a proper plan to show these numbers to them.
5. Prepare a Projection Risk Mitigation Plan
Startups should prepare for what would happen if any unexpected event threw off the projections. It’s also wise for a startup to have a contingency or risk mitigation plan ahead of time.
Plus, keeping aside a cash reserve in case of any problems is wise.
Conclusion
A financial forecast is crucial for the success and growth of a startup. Despite the uncertainties surrounding startups in their initial phases, thoughtful planning and financial forecasting can help them achieve break-even.
Working with specialized accountants is one-way startups can take steps toward an effective financial forecast that’ll lock in investors and help them see profitable outcomes.