by Adam Hoeksema
Financial projections are often required by lenders and potential investors, but for many startup entrepreneurs the process can become a nightmare. Where do you even start? Aren’t projections just a random guess? A waste of time?
Financial projections are typically a part of the fundraising process that you just can’t get around, but data can help improve the process in a number of ways:
1. Historical Data Gives You A Baseline
The best way to predict the future is typically to look at the past. So if you are an existing business with previous sales and expenses, this is probably the best place to start. Take your income statement from last month, or maybe an average income statement from the last several months and then apply a growth rate each month. If you are in a seasonal business and you have gone through a full annual cycle, you can use your results from last year to establish the months in which you expect sales to decrease and increase.
2. Industry Data Provides A Benchmark
Industry data can be particularly helpful for startups. For example, BizStats provides industry benchmarking data that you can use to determine whether your projections are within the realm of possibility. If you are starting a restaurant, BizStats can give you an idea of what your cost of goods sold should be as a percentage of revenue, or how much inventory you should have on hand as a percent of revenue.
3. Data Informs Your Assumptions
One key to doing financial projections right is to build your projections based on clearly defined, data driven assumptions. Lenders and investors are going to be looking for data points that tie to your assumptions. If you assume that you will convert 10% of your website visitors into customers, you better have some data to back that up. Ideally, the data comes from your historical results, but if that data is not available you might be able to find some ranges for conversion rates or growth rates for businesses like yours on sites like Quora.
Here are a couple of examples of questions and great answers that you can use to build your assumptions:
- What is a “typical” user growth rate for a hot web start up the first year?
- What conversion rate can be expected for a typical SaaS application using Google AdWords?
As much as possible, use data when developing your assumptions that build the basis of your financial model. Understanding the data behind what drives your financial model will prove to a lender or investor that you know your business and will be able to make good decisions to grow the business.
Adam Hoeksema is the Co-Founder of ProjectionHub which is a web application that helps entrepreneurs create financial projections for potential investors or lenders. ProjectionHub is like a TurboTax for financial projections.
r2hox | Courtesy of Adam Hoeksema