Are Your Financial Projections Fuzzy Math? Read On to Clear It Up
One reason projections feel like random guesses is because that's often what they are. You look at your top-line figures such as revenue and profit and assume a growth rate, such as 20 percent a year, without any real justification. That kind of guesswork isn't helpful. Instead, start from a foundation of concrete, reliable information.
1. Build Up From Concrete Information
Follow me on a quick equation: Let's say you run a plumbing or an electrical business. Start by estimating how many homes in your area could potentially use your services. Estimate how many you will contact over the year via your marketing strategy and, based on your track record, how many new clients you will pick up. Then, look at your average sale per client to get your extra revenue for the year. After subtracting expenses, you'll have a more accurate estimate of your annual profit.
I know what you're thinking. Technically, you're still predicting the future, but you're basing it off concrete information, which makes it more accurate. Also, if you fall short, you can look back at your assumptions to see what went wrong. Maybe you were not closing enough sales. Maybe your average sale was lower than projected.
Plan for the best, but be ready for anything. So forecast sales for three scenarios: A great year, an average year and a weak year. By making multiple projections, you're more likely to accurately predict what will happen.
2. Consider Multiple Scenarios
More importantly, you can start planning now for how you'll respond to these different scenarios. If sales grow more quickly than you expected, can your current staff handle everything or will you need to make some new hires? At what point does it make financial sense to hire someone new?
What if you have a bad year? How will your budget hold up? Can you still pay for everything out of lower-than-expected revenues or will you need to start making cuts?
Make sure to regularly review your predictions as the year goes on. This way, you can start adjusting immediately, like increasing marketing efforts if it looks like your sales are falling short.
3. Review and Compare
Compare your numbers with a similar business to determine their accuracy. Do you know another business owner in the same line of work who has a few more years of experience? They may let you peek at their past financial statements so you can identify any of your inaccurate assumptions such as, for example, underestimating expenses in the case of more sales.
You can also research average stats for your business online. Find figures like average annual revenue growth, profit margin and cost of goods sold and see how they compare. If you find some major differences, you need to rework your assumptions.
Do your financial projection homework and be better prepared, and you'll save time and build a stronger bottom line going forward.