There are some good reasons that you might need formal financial projections. The best reason is planning cash flow better. I wrote about the cash flow traps in the previous chapter; being aware of them is better than not, but with standard financial projections, you can take your sales forecast, expense budgets, and starting position and with a few reasonable assumptions you can project your cash. That, however, takes standard financial projections. The cash flow is like the link between your income and your balances. See the illustration above.

GAAP
You may run into the acronym GAAP, which stands for Generally Accepted Accounting Principles. Everything in this section is according to GAAP.

If you’ve done the basic numbers, you’re already more than half the way there. You’ve already estimated your future sales, cost of sales, and operating expenses. You’re very close to a standard pro forma income statement. Just add projections for interest and taxes, and you have that done.

From there you want to project your balances. What will happen with capital, assets, and liabilities? If you can set your starting balances to match your beginning-of-the-plan estimated guesses, then some rolling assumptions will take you right from there to cash.

In fact, my favorite way to make these estimates is to change and manage numbers in the cash flow and use those changes to automatically generate the balance sheet. I’ll show you how to do that in detail in this section.

Income vs. Balance vs. Cash
An income statement (also called profit and loss) shows your business performance over a defined period of time (usually a month or a year). This is sales less costs less expenses, which equals profits. A balance sheet, on the other hand, shows your financial position at some moment (usually at the end of the month or the end of the year). This is assets, liabilities, and capital. Assets must always be equal to capital (also called equity) and liabilities.The cash flow reconciles the other two. Not all your money received nor all your spending show up in the Income Statement, and not all of it shows up in the Balance Sheet. The cash flow links the two. And, much more important, shows where the money comes from and where it goes.

In the meantime, though, there are some standard conventions for the way these various statements link together. This is true in GAAP, true in Excel, in Lotus 1-2-3 if you do it right, and automatically in Business Plan Pro.

  • Your sales forecast should show sales and cost of sales. The same numbers in the sales forecast are the ones you use in the profit and loss statement.
  • As with sales, you should normally have a separate personnel table, but the numbers showing in that table should be the same numbers that show up for personnel costs in your profit and loss table.
  • Your profit and loss table should show the same numbers as sales and personnel plan tables in the proper areas. It should also show interest expenses as a logical reflection of interest rates and balances of debt.
  • Your cash flow has to reflect your profit and loss, plus changes in balance sheet items and noncash expenses such as depreciation, which are on the profit and loss. The changes in the balance sheet are critical. For example, when you borrow money, it doesn’t affect the profit or loss (except for interest expenses later on), but it makes a huge difference to your checking account balance.
  • The balance sheet has to reflect the profit and loss and the cash flow.
  • Your business ratios should calculate automatically, based on the numbers in sales, profit and loss, personnel, cash flow, and balance sheet.
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Tim BerryTim Berry
Tim Berry

Tim Berry is the founder and chairman of Palo Alto Software and Bplans.com. Follow him on Twitter @Timberry.