Key Considerations When Preparing a Financial Projection

One of the most common issues I observe in the financial projections of early-stage start-ups is that they usually focus only on income and expense projections instead of preparing a detailed cash flow statement. While your operations will indeed consist of revenues and expenses, their reflection in financial statements follows different principles.

Let’s start with the revenue side. An investor wants to understand how many products you need to sell or how many users you need to reach in order to achieve your targeted revenue. They will also want to see the price points at which you plan to sell these products or service packages. The first thing to keep in mind is that sales prices should not include VAT. Even though you may invoice with VAT included, it is not part of your actual revenue. VAT is a tax you are required to pay in the following month for the value you have added through your operations. If your expenses exceed your income, you may be in a carry-forward VAT position and usually do not make a payment. This is also how it is recorded in legal accounting.

How do you plan to increase your sales volume and user base in the coming periods? What is the key to achieving solid customer growth? To answer these questions, you should first calculate your customer acquisition cost. This means estimating how much advertising spend is needed to bring one customer into your operation. Then you need to define how long that customer will stay with you. In other words, what is the average customer lifetime in months or years? Once these figures are clear, you can estimate how much advertising spend will be required to reach your target number of users.

On the expense side, one of the most common shortcomings is the incorrect calculation of personnel costs. You may determine how many team members you need to focus on product development, sales and marketing, and estimate their net salaries. However, what about employer-related costs? If your projections are based on net salary payments, then taxes such as stamp duty, income tax and employer-side social security contributions must be included in your cash flow. These tax items can add up to nearly half of the salary. That said, if your company operates within a technopark, you may benefit from exemptions from these obligations.

Another factor not included under revenue or expenses but which still affects cash flow is working capital. For example, let’s say you made a sale but have not yet received payment from the customer or the payment provider. In this case, the revenue has not yet reached your bank account. Or, perhaps you agreed to pay your supplier with a 30-day term for the materials you use. Even though you incurred the expense, the corresponding cash is still in your account. That is why your business plan and financial projections should take into account industry-specific payment cycles, how many days it takes to collect your receivables, and how much working capital will be needed due to uncollected revenue over the year.

Overly optimistic projections may come across as unrealistic, while overly pessimistic ones might suggest you lack confidence in your own business. Therefore, business plans shared with investors should be well balanced and budget-grade. Most importantly, avoid projecting profitability during the entire projection period. Remember that being profitable is not mandatory. Of course, profit can be a great achievement for a fast-growing start-up. Still, the pursuit of profitability should not come at the expense of growth. As a start-up, you are likely to raise funding at least two or three more times and may not generate profit for five years. Show your potential investors that you are aware of this reality.

By putting your post-investment cash position and projected free cash flows side by side, you can calculate how much runway the investment will provide.

This is the first post in my series titled “The Importance of Cash Flow in Early-Stage Start-ups”, in which I briefly highlighted the key considerations for preparing financial projections. In the next post, I will focus on what to pay attention to once the first investment has been secured. I hope you enjoy reading it 😊