Creating Startup Financial Projections That Matter

Editor's Note — This article is written by Svitlana Grankovska, an experienced Fractional CFO with over 20 years of experience, who has helped numerous startups with financial projections and strategic planning. Drawing on a deep understanding of financial modeling, she shares essential insights on how to effectively predict and plan for future revenue, expenses, and growth.

To make smart decisions for your startup, you must have an idea of the money you will earn and spend in the future. But how can you predict your business’s future financial performance?

While you can’t know for sure, you can make fairly accurate predictions and plan accordingly by creating financial projections.

In this article, we cover all the basics you need to start defining and generating startup financial projections.

What are startup financial projections? 

Startup financial projections are a forecast of a business’s future income and outgoings. Creating projections involves making future versions of financial statements to show how your cash, revenue, and expenses will likely appear.

This is done by building cash flow statements, income statements, and balance sheets for points in time months or years ahead.

As part of these projections, businesses predict their financial situation based on hypothetical changes like a merger or IPO.

Depending on the approach you choose, you can build financial projections based on information about your industry and market or your business finances to date.

Startup financial projection is not financial forecasting or financial modeling

It’s not uncommon to see and hear financial planning terminology used incorrectly. While the terms ‘financial model’, ‘financial forecast’, and ‘financial projections’ are closely interlinked, they are not interchangeable.

We’ve outlined these three commonly-used (and misused!) financial planning terms below to provide clarity on how to use the different tools or processes.

• Financial forecasts: Often rooted in historical data, these are predictions of your financial performance based on what you expect to happen given current conditions and market trends.
• Financial models: These are spreadsheet or software-based representations of your startup’s finances that you can manipulate to make financial predictions.
• Financial projections: These are estimates of potential financial outcomes based on varying sets of financial assumptions about your business, often used to assess certain strategic decisions.

How to build startup financial projections

Here’s what you should include in your financial projections and why, plus guidance on how to build them.

1. Startup expenses 

In this context, startup expenses refers to the costs you expect to incur while getting your startup off the ground. It’s highly beneficial to create financial projections for them as a pre-revenue startup.

Since you aren’t generating enough revenue to cover your startup expenses, you’ll probably need to use external financing to fund them.

And whether that’s a business loan from your friends and family or an equity funding arrangement from an angel investor, projections are essential to inform the amount of capital you need to raise.

Here are some common one-time and recurring startup costs you may need to account for:

• Accounting services
• Business licenses
• Equipment
• Insurance
• Legal services
• Market research
• Marketing
• Payroll and benefits
• Product development
• Rent
• Software and technology
• Utilities
• Web development

Of course, startup costs can vary significantly depending on your business model. Consider including everything in your projections that you suspect might be necessary to get your business on the road to profitability.

Making conservative projections can help you avoid raising less capital than you need and having to seek additional funding sooner than you expected.

2. Sales projection

Sales or revenue projections typically use a combination of historical data, market research, and economic trends analysis to estimate your future sales in different scenarios, which should inform many crucial aspects of your strategic planning.

For example, that may include resource allocation, cash flow management, and–if you’re using a product-based business model–inventory management.

Sales projections can also provide helpful benchmarks. If you’re consistently falling short of your financial goals, you know you need to make adjustments, such as to your customer acquisition strategies.

There are several methods you can use to create your projections. Which one makes the most sense often depends on your startup’s growth stage and the data you have available.

For example, here are a couple types of revenue projection methods to consider:

• Opportunity stage methods: These methods involve analyzing your current pipeline to estimate future revenue. They may be suitable when you lack broader historical data but have insight into factors like customer sentiment and market trends.
• Time series methods: These methods take data from previous periods and assume a certain sales trend to project revenues. They’re ideal when you have significant historical data available.

If you need help with sales projection, consider working with a fractional CFO service, as they should have the necessary financial expertise to help. 

3. Operating expenses

Operating expenses are the costs you incur to support your day-to-day operations. Unlike startup expenses, which may only be necessary to get your business off the ground, operating expenses may recur indefinitely.

As a result, operating expenses play a significant role in your financial projections long after your early stage startup period. As a critical part of the income statement, they directly inform ongoing budgeting, revenue stream goals, and profitability analysis.

Historical data can be beneficial for operating expense projection, but it’s not always necessary. You can anticipate many of your costs by studying expense profiles of similar startups and adjusting them to match your unique spending plans.

Here are some common operating expenses you’re likely to encounter:

• Depreciation
• Equipment leases
• Insurance
• Marketing
• Office supplies
• Professional services
• Rent
• Repairs and maintenance
• Salaries and wages
• Software subscriptions
• Travel costs
• Utilities

Make sure to distinguish these operating expenses from your cost of goods sold or services. That refers to the direct costs involved in producing your product or service, such as direct labor and direct materials.

Also, consider separating your operating expenses into fixed and variable costs, as it can make adjusting your projections more intuitive. Fixed costs stay consistent each month, while variable costs can fluctuate depending on your activities.

4. Income statement

By combining your revenue and expense projections, you can create an estimated income statement for your startup that provides a comprehensive projection of your financial performance.

Since the income statement puts your revenues, expenses, and net income in context, it’s invaluable for analyzing the overall financial health and growth trajectory of your startup. It’s the ultimate lens into your profitability over time.

Fortunately, creating an income statement from revenue and expense projections is fairly straightforward. It involves little more than netting them together to calculate the results of your activities.

In order, here’s how you typically present everything on the income statement:

1. Revenues
2. Cost of sales
3. Gross profit (revenues – cost of sales)
4. Operating expenses
5. Operating income (gross profit – operating expenses)
6. Other income and expenses
7. Gains and losses
8. Net income (operating income ± other income and expenses ± gains and losses)

Once you have more extensive historical data, it becomes easier to create income statement projections. Instead of having to build them from separate revenue and expense projections, you can use previous income statements as a starting point.

From there, you can make adjustments based on established trends and your knowledge of anticipated events to create an accurate projection.

5. Balance sheet

The balance sheet is the second of the main financial statements. It captures your startup’s financial position at a specific point in time, such as the end of a quarter or a calendar year.

More specifically, the balance sheet documents your company’s assets, liabilities, and equity, which are often analyzed through financial ratios.

Here are some examples of accounts that may be included:

• Current assets: cash, inventory, and prepaid expenses
• Fixed assets: real property and equipment
• Current liabilities: accounts payable and income taxes owed
• Long-term liabilities: portion of multi-year business loans due beyond the coming year
• Owner’s equity: retained earnings and owner contributions

Projecting each type of balance sheet account may require a different approach, but it’s often more straightforward than it is with income statement accounts. For example: 

• Fixed assets depreciate at a predetermined rate
• Business loans follow a predictable repayment schedule
• Retained earnings changes by net income minus dividends

In many cases, balance sheet accounts change in lockstep with related income statement accounts. The two documents are closely interconnected, and you need both to get a comprehensive picture of your financial health. As a result, you usually project them together.

6. Cash flow statement

The cash flow statement is the last of the three main financial statements. It captures your cash inflows and outflows from all sources, including operating activities, investing activities, and financing activities.

Since startups often rely on financing to generate capital and scale their business until they can become profitable, running out of cash is a significant danger. As a result, cash flow management is especially important, and the cash flow statement is an essential tool for it.

Cash flow projection can help you identify potential shortfalls in advance, giving you time to make adjustments before you start having issues due to a lack of liquidity.

You can project your cash flow statement using one of two methods:

• Direct method: This involves predicting your cash inflows and outflows much like you estimate revenues and expenses, then calculating the net cash results.
• Indirect method: This method starts with your projected net income and works backward to adjust for non-cash transactions like depreciation.

If you already have a projected balance sheet and income statement to work with, the indirect method may be more convenient. If not, you’ll need to create them or use the direct method.

7. Cash burn projections

Your cash burn refers to the rate at which you’re spending your capital reserves. It’s particularly important to consider before your operation generates enough income to be cash flow positive or profitable.

That period can last for several years, during which running out of cash before or between fundraising rounds is a significant danger for venture-backed startups, as mentioned previously.

Like creating a projected cash flow statement, projecting your cash burn helps you avoid dangerous liquidity issues. Prospective investors may also use it to analyze your startup’s sustainability and inform their investment decisions.

There are two primary types of cash burn to consider:

• Gross cash burn: This represents all cash outflows during a given period, including the cost of sales, operating expenses, capital expenditures, and any other cash disbursements.
• Net cash burn: This takes into account your cash inflows, representing the net change in your monthly cash balance.

Fortunately, you don’t have to do much additional work to project these if you already have a cash flow statement. You can simply pull the figures from the document.

Need expert help building realistic financial projections? 

Projections can be time-consuming and challenging to complete, especially if you’re a first-time startup founder and lack relevant startup finance experience.

Likewise, the only way to get accurate predictions is if your data is error-free. This situation is difficult when you don't have someone to manage your accounts in-house.

If your startup could benefit from expert help with bookkeeping and financial projections, a financial operations platform might be what you need.

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