Financial projections are a key tool for startups, used to measure the potential success and sustainability of their business. These projections provide a planned roadmap, helping entrepreneurs and small business owners assess their current position and make informed decisions about their future plans. However, even the most carefully crafted financial projections can still be hindered by common mistakes made at the inception of a business. In this blog post, we'll outline the most common mistakes startups make when creating their financial projections.
- Understand what you need to include in the projection
- Get help from a financial advisor
- Put assumptions and hypotheses in writing
- Take a data-driven approach
- Test the model
Mistake 1: Overlooking Inflation
When creating financial projections for a startup, one of the most common mistakes is to overlook inflation and its effect on future investments. This mistake, if left unchecked, can cost a startup all of its hard-earned capital and, most importantly, its future success.
A. Not factoring in the projected cost of day-to-day business operations
One way that inflation affects startups is that it can cause the cost of day-to-day operations to increase over time. This means that any projections that do not take into account the projected cost of day-to-day business operations could be inaccurate and lead to unexpected expenditure. To protect the startup from this type of unforeseen outcome, it is important to factor in the estimated cost of their daily business activities and make sure that any financial projections account for inflation.
B. Failing to take into account potential future changes in the industry
The other way inflation affects startups is that it can cause changes in the market over time which can impact the profitability of the business. In order to ensure that the startup’s financial projections are realistic, it is important to keep an eye on changes in the industry and adjust financial projections accordingly. Without this type of foresight, a startup can find themselves facing unexpected costs and a decrease in their overall financial health.
Mistake 2: Not Planning for Unexpected Expenditures
The second most common mistake startups make when creating financial projections is not planning for unexpected expenditures. Startups consistently underestimate the cost of product development, which can lead to them having less profit and a longer timeline to recoup their initial investments. On top of that, they often fail to account for potential legal and tax complications that will arise in the course of doing business.
Underestimating product development costs
Product development costs are usually underestimated by startups because they neglect to consider all the steps that go into creating a successful product. Every item they need to invest in, such as development tools, raw materials, or outsourcing fees should be accounted for in the financial projections. This will help them account for the total cost of production.
Ignoring potential legal and tax complications
Another mistake startups make is not considering the potential legal and tax complications that come with running a business. There are many different regulations and laws to consider, and these can often be expensive to comply with. Ignoring these potential costs could severely limit the success of the business, as startups cannot make money if they are not compliant with the laws.
Mistake 3: Not Accounting for Future Opportunities
When creating financial projections, startups often fail to account for potential opportunities that could make a major impact on their profitability. This can be a costly mistake, as new opportunities can make all the difference between a successful and unsuccessful business.
Not taking into consideration how expansion or new customer bases could impact profitability
When creating financial projections, startups need to remember that not all potential benefits of expansion or gaining new customers can be factored into the current projections. For instance, a startup may need to invest resources in order to expand their customer base, and this cost may not be able to be accurately predicted. Additionally, a startup may not be able to accurately predict how efficient their new customer base will be at driving profits.
Not forecasting beyond the present horizon
Startups also often fail to account for potential opportunities that may arise in the future. While it may be difficult to accurately forecast beyond the present horizon, it is important to consider and plan for the future. This includes looking at the potential for new opportunities, as well as understanding the impact of the industry climate and any external factors that may affect the business. By taking the time to look to the future, startups can be better prepared to take advantage of any new opportunities that may arise.
Mistake 4: Not Considering Timing of Cash Flows
When startups are creating financial projections, one common mistake is failing to take into account the timing of when their cash flow will occur. It is essential for entrepreneurs to understand how long it will take them to receive payments from customers. Without a clear understanding of this timeline, the business may experience unexpected and avoidable cash flow misalignments.
A. Not being aware of the amount of time it takes to receive payments from customers
For instance, if customers typically take 30 days to pay invoices after they are issued, startups must create financial projections that take this timeline into account. Failing to do so can result in a cash flow gap between when expenses are due and when revenue is expected to come in.
B. Not allotting time to pay out monies due
Additionally, startups must consider the time associated with paying out monies due. This could include payments for goods and services, payroll, taxes and so forth. If not accounted for in the financial projections, startups may be left scrambling when certain expenses become due and they do not have the cash to cover them. To avoid this, entrepreneurs should plan ahead and factor in any expected payments when creating their financial projections.
Mistake 5: Not Understanding the Entire Process
Creating financial projections requires a methodical approach that requires an understanding of accounting, taxation and the market climate. Many startups make the mistake of not fully researching and comprehending the various steps involved in setting up their projections.
Failing to Fully Research and Understand the Various Steps Necessary to Set Up the Financial Projections
Before you create financial projections for your startup, it’s important to understand the entire process, such as how to record revenue, expenses, and cash flow. This includes understanding the components of a balance sheet and how it impacts the other components of the financial statements, such as the income statement, statement of cash flows, and statement of owner’s equity.
Startups should also be knowledgeable about the reporting requirements needed to ensure compliance with all applicable laws, regulations and industry standards. Having a thorough understanding of the reporting requirements and understanding the implications of any potential changes or restrictions can help to ensure that the projections are accurate.
Not Consulting a Professional
For any project, it is imperative to have a solid understanding of the complexities of the task and a plan for completing it. While many entrepreneurs feel certain about their capabilities and understand the various steps associated with setting up the financial projections, consulting a professional may be the best way to move forward.
Engaging the services of a qualified and experienced accountant can be beneficial to any business, as they can provide expert knowledge of the accounting and taxation rules that may be applicable to a startup. Additionally, a professional accountant can provide advice on the most effective ways to structure the financial projections, helping to ensure that they are accurate and up to date.
Creating financial projections for your startup is an important step for the success of your business. Accurate and detailed financial projections can give a complete picture of where your business stands and provide a vision of where it is headed. To create these projections it is important to thoroughly understand the process, take into account every detail, and avoid the most common mistakes.
The most common mistakes startups make when creating financial projections include:
- Inadequate research and short-term thinking
- Ascribing too much value to the venture
- Presenting overly optimistic growth forecasts
- Failing to consider the effect of inflation
- Inadequate cash flow planning
- Not budgeting for contingencies
Creating detailed financial projections with an eye to the future and a realistic view of the present is the best way to ensure the success of your startup. A thorough understanding of the process and proactive planning can help you avoid the common pitfalls of financial projections, setting your startup up for long-term success.