Financial projections provide important information for any business and play a vital role in av style design, business planning, budgeting and forecasting. They are critical for analyzing the expected performance and financial viability of a business idea, new venture or existing company. In this blog, we will explore various types of financial projections and key terms used in financial analysis.
Cash Flow Projections
Cash flow projections estimate the amount of cash flowing in and out of a business over a period of time, usually monthly or annually. The main components of a cash flow projection are cash receipts from sales/revenues and cash disbursements from expenses. It’s important for businesses to track cash flow closely as running out of cash can be catastrophic. There are three main types of cash flow projections:
Projected Cash Flow Statement
This projection estimates the changes in cash over a period by listing cash inflows from sales/revenues and cash outflows from operational and capital expenses. It includes beginning cash balance, cash from operations, cash from investing and cash from financing activities. A projected cash flow statement helps evaluate whether a business will have sufficient cash to meet obligations and stay in operation.
Projected Operating Cash Flow
This focuses only on projected cash inflows and outflows from core business operations. It excludes non-operating transactions like investments, financing activities and tax payments. Operating cash flow projections analyze whether operational revenues will cover expenses on an ongoing basis.
Projected Free Cash Flow
Free cash flow projects cash flow available after all operational and capital expenses that can be distributed to owners or used to repay debt. It’s calculated as net operating cash flow minus capital expenditures. Positive free cash flow indicates ability to self-finance growth without external funding sources.
Profit and Loss Projections
The profit and loss (P&L) projection, also known as projected income statement, estimates revenue, costs, expenses and profits over a period of time. The main components are:
Projected Sales/Revenue
An estimate of total sales or revenue generated from a business’ products/services over the projection period. Factors considered are target market size, growth rates, pricing and sales goals.
Projected Cost of Goods Sold (COGS)
Estimate of direct costs attributable to production of goods/services sold which reduces gross profit. It includes material costs, direct labor, production overheads etc.
Projected Operating Expenses
Estimate of both fixed and variable expenses needed to run ongoing business operations like rent, salaries, marketing, administration, utilities etc.
Projected Operating Profit/Loss
Calculated as projected revenues minus COGS and operating expenses. It shows whether a business is expected to earn a profit or loss just from core operations.
Projected Net Profit/Loss
Calculated after accounting for non-operating income/expenses like interest, depreciation, taxes. It shows overall profitability including financing costs.
Balance Sheet Projections
The balance sheet projection estimates asset, liability and equity accounts at a point in time. It reflects the financial position of a business on a given date. Key elements include:
Projected Assets
Estimates of tangible assets like cash, inventory, equipment and intangible assets like intellectual property, goodwill etc. expected to be owned.
Projected Liabilities
Estimates of financial obligations owed like accounts payable, loans, accrued expenses, deferred revenue etc.
Projected Equity
Projection of owners’ claim represented by initial investment, retained earnings or accumulated profits/losses.
Ratios and Common Financial Terms
Key financial ratios help analyze the financial health and projections of a business. Some common terms include:
Gross Margin
Calculated as gross profit divided by sales/revenue. Measures profitability at the basic operations level before operating expenses.
Operating Margin
Operating profit divided by sales/revenue. Shows profit generation ability after operating costs are considered.
Net Profit Margin
Net income divided by sales/revenue. Reflects overall profitability including financing costs.
Return on Equity (ROE)
Net income divided by average shareholders’ equity. Measures profit generation in relation to owners’ investment.
Return on Assets (ROA)
Net income divided by total average assets. Indicates overall effectiveness at utilizing deployed assets.
EBITDA
Earnings Before Interest, Taxes, Depreciation and Amortization. Used to measure operating performance independent of capital structure.
Working Capital
Current assets less current liabilities. Measures liquidity and ability to meet short term obligations.
Cash Ratio
Cash and near cash assets divided by current liabilities. Stringency measure of liquidity.
Debt-to-Equity Ratio
Total debt divided by total shareholders’ equity. Indicates financial leverage and associated risks.
Conclusion
In summary, financial projections allow entrepreneurs and business managers to plan strategies, allocate resources effectively and monitor performance against milestones. Regular revisions keep projections aligned with changing business conditions. Pro forma financial statements coupled with key metrics provide a meaningful roadmap for growth and success.