With the ‘start-up’ culture exploding around us and fundraising pitches and loan applications a routine part of every entrepreneur’s daily grind, I see a surprising polarity of views about the usefulness and relevance of financial projections and how to go about them.
Opinion seems divided between a frankly anal obsession with detail on the one hand, and a total disregard for any possible relevance of largely speculative numbers on the other. The truth of course, like so much in life, lies somewhere in the middle and it will save entrepreneurs time and money (and not a little pain) if they were to understand how to get this issue into perspective.
Of course there’s one overriding consideration and it’s quite simple. You don’t have a choice about doing them. Whatever your views about their merits, virtually any process involved in fundraising will require a set of numbers of some sort. Whether it’s a basic cash flow for a small start-up loan or something more weighty to support the hunt for a big investor, you’re unlikely to get away without them. Even an organisation like the equity crowdfunding platform ‘Seedrs’ who openly decry financials as inappropriate for an early stage business belie the fact that their forums are packed with investors requesting the very information they have discouraged providing.
So if on some level you’ve got to do them, how do you know what’s the right approach? The answer is first to understand what they’re for.
You create financials for a mix of two basic reasons. First so you, yourself, understand your own numbers. (We’ve all seen Dragons’ Den. We know what happens when people don’t understand their own figures. It’s not pretty.) Second, it’s so you can communicate those numbers to someone else – usually someone who’s going to lend or invest money.
Once you’ve grasped these objectives, the next thing to recognise is that you haven’t got a crystal ball. Much as you’d like to you can’t actually predict the future, so stop trying. Instead recognise that the purpose of projections is simply to paint a financial picture; to set out the broad financial characteristics of your business as a basis for a consideration of potential, viability and risk.
So although it may sound simplistic, remember: the quality of any financial model is defined only by how well it helps you or your reader actually understand the financial aspects of your business. After all it’s why you’re doing them in the first place.
Once this is understood something interesting happens. Those in the “financials are entirely pointless” camp realise that there is at least some useful information that needs to be understood and got over. While those who build endlessly complex models of things they can’t possibly predict realise that this adds little to their own or their reader’s genuine understanding. (In fact it’s likely to hamper it.). With a bit of luck we end up in the middle, where we need to be.
And the keys to good numbers are equally simple.
- Too much detail is as bad as too little. Get the level of detail right and you’re halfway there.
- Opening balances matter. The first fundamental of any set of projections is “where are we now?” – what’s our current financial position? Without this it’s meaningless. If your books aren’t up to date, get them done.
- Use a standard accounting structure (P&L cash flow and balance sheet) and don’t be fooled into believing you can do a cash flow without a fundamental consideration of your profit and loss and balance sheet issues. If you don’t understand the basics of this stuff, find someone who does.
- Make sure you produce a concise, readable pdf document that’s well-labelled, and legible on screen and when printed. And never circulate raw spreadsheets.
And last: don’t make a meal of it! I usually advise early stage businesses that if they spend more than half a day on their forecast they’re probably doing something wrong.