How to ensure your financial projections are not way out of reality?

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It’s important to have a plan and very important to have a plan which is close to reality.  Though factual progress can be different to plan, still it is important to have a plan / projection in the first place and keep adjusting as time progresses according to changing situations.  Some of the key points to be kept in mind to avoid pitfalls while making financial projections:

  1. Do your research properly:  Know your subject, industry, its challenges and issues so as to be able to make right assumptions to estimate capital expenditure, operating expenditure etc.  sometimes, non estimating or under estimating an expenditure can trigger chaos while running your operations.  Speak to experts in the industry or atleast your operations team who may help you bring clarity.
  2. Be Pessimist cum Optimist: Humans tend to be over positive when doing their financial projections, either they will over estimate revenue generation and expect the markets behave according to their excel sheets or under play expenditure thinking stringent controls.  If you cannot help to be an optimist, then please have another financial projection with pessimistic view (generally discounted by 70 to 80% of optimistic projections) on hand.  You can also take an average view.  If you have a nasty friend who can make opinion straight on your face… please ask him to vet the projections!!! It may help.
  3. Don’t forget to project Cashflow: Fail to project cashflows at your own peril.  Money on hand is better than money in receivables; hence financial projections should have a detailed table on cashflows and net shortfall.  This will also help to avoid working capital trap (it is vicious… once you get in… it is difficult to get out… mind you!!!).  Do project potential defaults and delays in cash collection (we tend to be over positive on ability of customers to pay on time).
  4. Use important Metrics:  Some critical financial ratios can help to understand performances better.  They can be ratios like Return on Capital, Internal Rate of Return (IRR), Gross Margin Rate, Net Profit Rate, Return on Net Worth, Stock Rotation Rate, Working Capital Cycle Rate.  Try getting industry benchmark metrics against the above ratios and test them on your projections. (Align Associate has repository of Industry Performance Indicators which can help you benchmark against best practices made available to you through their Real Time Dashboards – About this in another article!!!)
  5. Costs always go up! :  don’t forget to apply inflation in costs as it is tend to happen naturally.  Please study the current inflationary trends while applying.  Also many times, we forget to apply taxation and other statutory compliance costs while building projections.

If you are not too good in financials or accounting, don’t forget to take help of an expert, they can cut down your learning time and add immense value to your projections.

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