Of all the steps and processes involved in starting up a new business, coming up with solid, realistic financial projections as part of the business plan is one of the most critical. Financial projections are both a tool for securing a loan for your intended business endeavor and a roadmap to keep you focused and on target.
Rick Revetria, managing director of business consulting Sensiba San Filippo, an accounting and business advisory firm in San Francisco, offers five important tips for developing strong, accurate financial projections for your new business:
1. Determine—realistically—the size of your marketplace. First understanding the size of your marketplace will give you a good idea of how much market share you can expect to achieve, Revetria says. “Reach is important. And if you’re a retailer trying to set up a neighborhood coffee shop versus an Internet retailer, that reach is going to be different,” he says.
Local chambers of commerce, city planning departments and even local news media organizations can all help start-ups gain a sense of the marketplace. But nothing beats getting out and doing your own research, Revetria says. “If you are choosing a location in a shopping mall, go and sit on a bench there for an hour and count people,” he says. “Or if you are opening a coffee shop on a downtown street corner, go and physically observe how many people walk by and what time of day people walk by.”
2. Avoid over-estimating revenue. “At the end of the day, overestimating revenue will kill a business,” Revetria says. He uses restaurants as an example. Ninety percent fail in their first year of operation for two reasons: First, the location isn’t ideal. Secondly, the owner overestimates what he or she could do in the first year.
To avoid overestimating revenue, get back to basics—why you’re going into business in the first place and how big you’d like to be. “Lots of times, new business owners get enamored with the idea,” he says. “You have to think through what you’re selling and what you’re trying to do.”
3. Be careful not to underestimate costs. It’s common for new business owners to fail to account for all the costs involved in launching a business, from security deposits to business licenses to utility deposits. These days, you also have to recognize that credit isn’t easy to obtain for new businesses. “Startup costs are typically higher than you expect,” Revetria says.
On top of that, financial projections must account for the fact that business will increase over time, but the first year will be slow. “If I am going to do $12 in my first year, for example, I might not even do a dollar the first month,” he says. “Traffic is built up over time as you start to gain repeat business.” For this reason, it’s important to include all living and business expenses for a year—including a year’s worth of salary—in financial projections.
4. Get help. Revetria suggests asking your spouse, a good friend or the like review the financial projections and challenging you on it. Professional accountants or business consultants can provide a more formal review. Local businesses can be a valuable resource for recommendations on these professionals. “If they aren’t a competitor, they will likely be more than willing to help,” he says. “Befriend them. Find out who they used, and try to understand some of the things they ran into when they started up their business.”
Whomever you turn to for advice, put your financial projections to the test. After all, “everything you own is on the line when you go into business,” he says.
5. Continuously re-assess your original financial projections. All parts of the business plan—financial projections included—should be constantly returned to and re-evaluated, Revetria says. “It’s not something you put on the shelf and leave there for years,” he says. “Go back and re-assess the projection, how accurate it was, how it should be adjusted and what you can learn from it. That should be part of a regular routine.”