Creating Financial Projections

Choosing the Right Approach

The final piece of your business idea is the financial projections. You need to have a fairly solid idea of what your business is going to cost to run and how much revenue it’s likely to generate. We recommend using a basic bottom-up method, where you generate estimates for each part of the business and then combine them to get the big picture.

Finding Data

As an entrepreneur starting a new business, you have a major disadvantage when forecasting revenue and expenses: you have no historical data to base your facts on. This means that you will have to obtain data for similar companies in your industry and geographic area. Your expertise, and the expertise of your team, will also be invaluable.

Part One: The Sales Process

The first part of financial projections is looking at your sales process. How long will it take for your company to see payment after someone becomes a potential customer? Typically, customers move through the following stages:

If you’re a hot dog vendor with walk-in customers, then your sales process is quite short. If you’re selling luxury vehicles, then your sales process could be quite long. To help you get an accurate picture of how long your sales process is, you can use this template. We have included some example activities for a small business selling custom bicycles.

Sales StageActivities in Our ProcessAverage Length of Stage
LeadCustomer visits our website and fills out contact form0-48 hours after first website visit
ProspectCustomer service representative contacts customer, confirms information, and obtains additional details in order to provide a custom quote.Within 24 hours of form being submitted
Qualified LeadCustomer service representative re-contacts customer to provide custom quote. Credit check is also performed. Within 72 hours of last contact
Committed LeadCustomer signs agreement for custom bicycle.0-72 hours of custom quote
CustomerCompany ships bicycle.Four weeks after agreement is signed
Customer sends payment.0-48 hours of shipping confirmation
Total Average Length of Sales ProcessFour and a half to six weeks

You should also consider these factors when you are estimating the length of your sales process:

  • What experience does the market have with this product? New products and technologies can take a while to catch on.
  • What does the customer have to do in order to buy the product? Are credit terms, payment plans, proposals, tenders, or other lengthy processes required?
  • Who will be involved in making the decision? For example, company employees may be allowed to purchase small amounts of office supplies, but will need approval for bigger items.
  • How urgent is the purchase? A higher urgency level usually results in a shorter sales time.

Part Two: Sales Metrics

The next part of your financial projections is sales metrics. You will need to determine:

  • How much money each product will sell for (separated into one-time and recurring revenue)
  • If applicable, how many sales each salesperson can make (account for ramp-up time)
  • If applicable, how many salespeople you will have
  • Daily, weekly, monthly, and yearly sales estimates

So, let’s say that you have these figures for your new bicycle company:

  • You estimate that each product will sell for $100.
  • You will have five salespeople. For the first two months, you estimate that each salesperson will make five sales per working day. After that, their sales will double.
  • 25 sales per day, times approximately 25 working days in the month, equals 625 sales per month for the first two months. This equals $62,500 in revenue for months one and two.
  • After that, if all factors stay the same, revenue will be $125,000 per month.

Let’s look at an e-commerce company:

  • You estimate that each product will sell for $100.
  • You will not have salespeople; all sales will be done through your website.
  • You estimate that five people will purchase from the website on launch week, with the number doubling each week after that until it plateaus at 1,000 customers purchasing each week.
  • Since the first month is a four-week month, this means 75 sales and $7,500 in revenue in the first month.
  • The second month, which is also four weeks, will have 1200 sales and $120,000 in revenue.

It can be very difficult to predict sales estimates. Always err on the conservative side. As well, be sure to allow for seasonal variances. As your business grows, you will be able to update end refine your forecasts with actual data.

Part Three: Expenses

The final piece of the financial projection puzzle is your expenses. Luckily, your major expenses should be fairly easy to estimate. Here is a list of things to consider.

One-Time Costs

  • Lease deposits
  • Assets
  • Initial office setup (chairs, computers, desks, etc.)

General Overhead Costs

  • Rent
  • Heat, lights, and water
  • Communication costs (landlines, cell phones, Internet, etc.)
  • Office supplies

Staff Costs

  • Salaries
  • Commissions
  • Benefits
  • Owner payouts

Advertising and Marketing Costs

  • Advertising expenses (break down into appropriate channels)
  • Trade shows and conferences
  • Client expenses

Product Costs

  • Labor costs
  • Material costs
  • Packaging

Special Costs

  • Licensing and registration fees
  • Professional service fees (accountants, lawyers, etc.)
  • Insurance
  • Outsourcing fees
  • Emergency fund

Double and triple-check your expense forecasting to ensure you’ve accounted for everything.

Part Four: Calculating Ratios

You now have all the information you need to calculate the key ratios that will tell you if your business, as you have forecasted it, will be a success.

Gross Profit Margin

Gross margin shows you what the company has made in profit. It is calculated with the following formula:

The results are then multiplied by 100 to obtain a percentage. For example, let’s say that Acme Widgets made $100,000 in revenue last year. It cost them $50,000 to make the widgets. This means that their gross margin was 50%.

Operating (Net) Margin

The operating margin shows what proportion of the company’s revenue will be left over after all expenses are paid. Its formula is simple:

The results are then multiplied by 100 to obtain a percentage.

Head Count per Client

The final ratio that you should calculate is how many staff you need to support each client. If you know that a team of 10 people (including sales, support, and manufacturing) can make 500 widgets, and that each client buys five widgets at a time, your head count per client is one person per ten clients. This ratio will help you plan operations and resources to match your company’s growth.