Creating Financial Forecasts for Your Business Plan

To create a business plan that is useful to you and potential investors, you'll need to be able to do some number-crunching. Projecting the finances of your business may seem intimidating or difficult, but in reality it's not terribly complex. Basically, it consists of making educated guesses about how much money you'll need to spend and how much you'll take in, then using these estimates to calculate whether your business will be sufficiently profitable.

Predicting and planning the finances of your business is important not only to attract investors, but also to demonstrate to you and your family that your business idea will fly. If your first projections show your business losing money, you'll have an opportunity while still in the planning stage to make sensible adjustments, such as raising your prices or cutting costs. If your projections show your customer base growing gradually, you can plan for how you will get through the initial lean months. If you neglect to make financial projections, you won't realize your plan is a money-loser until you actually start losing money. At that point, it may be too late to turn things around.

Nonetheless, many new entrepreneurs avoid crunching their numbers, often due to fear that their estimates will be wildly off-base and yield useless results. This is a poor reason to avoid forecasting your finances. If you do your best to make realistic predictions of expenses and revenues and accept that your guestimates will not be absolutely correct, you can learn a great deal about what the financial side of your business is likely to look like in its early months and even years of operation. Even a somewhat inaccurate picture of your business's likely finances will be much more helpful than no picture at all.

For a basic understanding of your business's projected financial situation, you'll need to make the following estimates and calculations.

A break-even analysis. Here you use income and expense estimates for a year or more to see whether, in theory at least, your business will be able to turn a profit. If you have trouble projecting a solid profit, you might need to consider abandoning your idea altogether.

A profit/loss forecast. Here you'll refine the sales and expense estimates that you used for your break-even analysis into a formal, month-by-month projection of your business's net profit for at least the first year of operations.

A start-up cost estimate. As the name suggests, this is simply the total of all the expenses you'll incur before your business opens. These costs should be included in your business plan to give a true picture of how much money you'll need to get your business off the ground.

A cash flow projection. Even if your profit/loss forecast tells you that your business will have higher revenues than expenses, that doesn't mean that you'll always have enough cash available on key dates, such as when rent is due or when you need to buy more inventory. A cash flow projection lays out how much cash you'll have—or how much you'll be short—month by month. This lets you know if you'll need to get a credit line or set up other arrangements to make sure funds are available.

To make these financial forecasts, you could use accounting software, a simple spreadsheet program such as Excel, or even a calculator and some blank ledger sheets. With accounting software, most of your calculations can be done automatically with the click of a button, which can be very helpful when you're in the planning stages and trying out lots of different numbers.

If you plan to use software for bookkeeping and accounting once your business is started, you might as well also use it to prepare your financial projections. Accounting software is relatively easy to figure out and will definitely save you lots of time in the long run. Quickbooks, Quicken Home & Business, MYOB Accounting, and Peachtree Accounting are very popular and priced within reach of just about any budget. Magazines such as Home Office Computing, Macworld, and PC World are good sources of information on other programs.

When you're done with your financial forecast, you should be able to tell whether your business will actually make enough money to pay the bills and turn a profit. Assuming the answer is yes, you'll also see whether you need to obtain start-up money from investors or lenders and, if so, how much. Finally, once your business is up and running, you can refer back to your forecasts to see how your performance is measuring up.

Excerpted from The Small Business Start-Up Kit; A Step-by-Step Legal Guide, by Peri H. Pakroo (Nolo).

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