Financial statements are the basic building block for understanding how a business is doing. They provide management a way to assess the results and consequences of past decisions. However, because financial statements reside in the past, they are limited when you use them to forecast the future. While there does not exist a fool-proof way to forecast the future, there does exist a reasonable best-guess method to forecast how things may turn out. This is where financial projections come in.
Like historical financial statements, there are 3 basic financial projection reports:
Most professionals will produce projected income statements. Some will produce projected cash flow statements. However, few will do projected balance sheets!
It is important to note that this is not a budget. It is a projection.
Budgets are static. Thus, they are often only created once a year. Update the Dynamic Cash Flow Projection at least 12 times a fiscal year, if not more. The purpose of these projections is to manage your business based on where you are headed today… Not where you thought you were headed 8 months ago.
These financial projections typically cover an entire fiscal period of 12 months. They are also based on best-guess assumptions. Some more sophisticated companies and practitioners will go so far as to create best case, worst case, and probable financial projections. These in turn are based on best case, worst case and probable assumptions for the company’s future business prospects.
Each of the 3 financial projections tells a different story about the company.
A projected I/S provides management an idea of how the company’s profitability will look 12 months into the future. This projected profitability rests in large part on management’s ability to forecast industry and customer demand, costs, as well as many other macro- and micro- economic factors.
The ability to forecast revenue is the most important skill to develop in forecasting financial statements.
The projected CFS provides management with an idea of how the firms liquidity will be impacted given the business assumption inputs for the I/S projection. The projected CFS seeks to answer questions such as:
The projected B/S allows management to know the state of its asset, liability and equity base. The projected B/S also allows the company to project debt levels and covenants.
As business expands or contracts so too will the firm’s assets, liabilities and equity.
Click to download: Dynamic Cash Flow Projection