What Are Financial Projections? (With Types And Benefits)
Updated 25 September 2022
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Business managers often refer to financial forecasts and projections when making critical business decisions. These projections offer various insights and information about the future performance of a business, which may help attract investors. If you are a finance professional, understanding the concept of financial predictions can help you manage the expenses and revenue of a business. In this article, we discuss what financial projections are, share their benefits and list the different types of projections.
What Are Financial Projections?
Financial projections are documents financial managers create to predict an organisation's future income and expenses. Companies use these documents to moderate their budgets, decide their investments and design their operating plans. These are also useful to predict how successful a given project might be. These projections can help you compare the potential of an idea and the present revenue of a business. Through this comparison, companies can learn more about the sales capacity of a new venture.
Financial predictions in businesses are usually short-term or long-term projections. A short-term projection is mainly for new companies, covering the first year and providing monthly predictions. A long-term projection is usually for the next three to five years of a business and is useful in attracting investors and planning strategic developments.
Related: What Is Venture Capital? (With Steps And Benefits)
What Are The Different Types Of Financial Predictions?
There are different types of financial data projections, such as:
Cost projections: Businesses can predict the costs involved in their company's future, such as those related to marketing, product development and investments in technologies and new processes. These help a business understand the money it might require in the future to invest in the company's further development.
Cash flow projections: This category discusses a business's revenue and future expenses. It shows the company how much cash may be available for all future expenses.
Capital budgeting projections: When a company requires resources for a project, it utilises capital budgeting projections. This is helpful in understanding whether an investment might be worthwhile in the future.
Operating budget projections: These are financial statements that indicate how much money a business might require to conduct its operations in the future. For example, this can help the companies determine whether they can spend money on their marketing campaigns, research new products or change their pricing strategy.
Treasury projections: If you wish to learn how much the business might require to finance its operations and investments in the future, treasury projections can help with that.
Pension plan cash flow projection: This type of projection indicates how much money a business requires to sustain a pension plan and pay out the benefits for retirees. Companies that have established benefit pension plans and wish to improve their finances by lowering their liabilities and risks in the future often require this information.
Sale of company projections: These financial statements are essential to understanding what may happen if a company sells or shuts its business. For instance, it gives them an estimate of the money an employee might receive due to losing their job after the sale of the company.
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Benefits Of Financial Projections
Financial predictions have several benefits in business planning and the strategic development of a company. Some typical benefits include:
Provides estimates regarding future sales
Companies can gain insight into their future profits and revenues through financial predictions while also knowing where the current income originates. Through this information, a business can accordingly plan its pricing and marketing while making more informed decisions regarding the resources it might require for further development. For instance, the data they collect can help them decide if a new product might help gain new customers and determine how much to charge for the product.
When the company creates solid business plans and can illustrate the growth and trajectory of the company by using financial predictions, it helps to attract investors to invest their money in the company. An investor is more likely to invest in a business when the financial standing of the business is clear to them. Economic predictions may also be necessary when attempting to obtain certain types of business loans.
Related: What Is An Angel Investor? (Advantages And Disadvantages)
Helps in planning budgets and capital expenditures
Planning capital expenditures and budgets become much easier with the help of financial predictions. For example, if the company estimates its current operating budget using cash flow projections, this information might help in projecting the capital expenditures the company can earn in the upcoming years. Companies can use this information when assessing potential financial investments.
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Anticipates cash flow
By estimating the money a company currently has, it can anticipate the future cash flow. This can also give you insight into when to spend a certain amount, how to pay specific expenses and how to decide about the inventory. For instance, when a business has access to financial prediction, it can help them determine if it is feasible to buy a huge list of a product right away or if it is wiser to wait till the next month.
Related: Format Of A Cash Flow Statement (With Methods And Examples)
Directs how to manage resources
Financial predictions also help a business evaluate the resources that it may require to create its service or product. Businesses generally use various projections to determine whether to invest in an idea that might be successful. Deciding the resources the company might require can help determine if it can afford to take risks.
Helps in calculating return on investment
Financial predictions can also help determine if an investment might pay off and calculate how much profit it may make for the company. For instance, a business can use finance projections to decide if it can go into debt while financing its new product line. Using this data, you can access the holistic performance of an investment.
Related: What Is NPV? (With Advantages, Formulas And Examples)
Helps secure loans
Banks or financial institutions look into the company's financial status when they apply for a loan or line of credit. This entails not only providing them proof regarding the current financial records but also documents that state how the management envisions the business to grow in the upcoming years. Through solid financial predictions, companies can often get loans that they can use to build or improve their product or service.
Related: What Is Debt Financing? (With Advantages And Disadvantages)
Financial Forecasts Vs Financial Predictions
Here are some similarities and differences between the two:
Both financial forecasts and projections are forward-looking statements. They predict future outcomes based on specific assumptions and calculate outcome probabilities. Both these data sets produce results that are more reliable over the short term and less so over the longer term.
Financial forecasts occur when companies look at projected or historical data from businesses in the same category to develop predictions. Since they link their deductions to historical data, the presence of assumptions is much fewer in comparison to financial data projections. As a result, businesses often deliver economic forecasts at lower levels of detail, such as segments like sales or profits. Even though forecasts and projections are not necessarily limited to the time frames they represent, forecasts tend to concentrate on shorter-term expectations. Generally, financial forecasts are market-facing analyses that intend to communicate potential outcomes to investors and interested observers.
Companies look into numerous financial statements to derive financial predictions, basing their predictions on what they believe might happen in the future. These usually create financial predictions at the highest level of detail to show all the expenses and revenues that may occur in the future. Projections may address either long-term or short-term scenarios, and they are typically for internal usage for the company's board of directors and management. It gives the management an idea of what might happen due to any strategic decision.
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