4 Deadly Financial Projection Mistakes
Note: This is a guest post by Adam Hoeksema, founder of ExecutivePlan, which helps entrepreneurs write business plan executive summaries to raise capital. More of his information is at the bottom. We’re excited to have him on the blog today:
If you are applying for a business loan or seeking to raise capital from investors, you have probably developed a set of financial projections as part of your business plan.
Financial projections are incredibly difficult to get right. In fact, some investors have even said that 100% of financial projections are completely wrong, it is just a matter of whether the actual results will be higher or lower.
Related Post: 4 Ways Financial Statements Will Thwart Your Funding
Look, you will make mistakes, but some mistakes are much worse than others. Here are 4 mistakes that can be deadly:
Will your cost of doing business drastically increase if gas was $6 a gallon, or if corn prices doubled, or if other commodity prices jumped through the roof? If you plan to operate a delivery business where 35% of your total expenses will be spent on fuel, then you must plan for fluctuations. Run the numbers. Will you still be in business if gas prices jumped 20% as they so often do? Your financial projection models may show various scenarios. At the very least, this will help your banker or potential investor know that you have thought through the best and worst case scenarios.
Sales Conversion Rate
Whether you are selling beef jerky online, or cereal at Wal-Mart, your product or service will have a certain conversion rate. If you are selling online you might project 100 website visits per day with a 5% sales conversion rate. If you sell your product for $100, that is $500 in revenue per day. Your conversion rate is more important than the number of visitors to your site. For example, if you increase your visitors by 1% your revenue will inch higher to $505 a day. But if you increase your conversion rate by 1%, up to 6%, you will see revenue of $600 daily. The point is, you need to put in the research to project a conversion rate that is reasonable based on your industry. Just a couple percentage points will be the difference between incredible success and bankruptcy.
Related Post: The One Ratio No One Talks About — Except Your Banker
Bad Debt Percentage
In almost every business you will have some percentage of customers that just won’t pay. This is called bad debt. Some industries have much higher bad debt percentages than others. You need to research your industry to determine what a typical bad debt percentage is. If you can’t collect 3% of your sales, you need to plan for that, or you might as well kiss your profit margin goodbye. If you fail to collect 3% of your sales you will need to increase your pricing or decrease your expenses in order to keep your bottom line from suffering.
Days to Collect Receivables
Even more deadly than misguided bad debt projections: misunderstanding how long it will take to collect accounts receivable. That could wreak havoc on your cash flow. As you develop your cash flow projections, you need to make sure that you understand the average number of days it should take to collect your receivables. If you project 30 days, and it actually takes 60, you have a couple of options. First, you could offer a 5% discount if the customer pays in 10 days, or you might not offer a discount and simply push back paying your bills for another 30 days. Either option has negative consequences on your bottom line. The key is to leave yourself some breathing room, expect your customers to pay late, and keep a close eye on cash flow each month.
Take a close look at your financial projections today. Bankers and investors understand that you can’t predict the future of your business perfectly, but you can keep from making any of these deadly mistakes. Run some different scenarios with your projections, and provide a best- and worst-case projection for your own sake. Keep these 4 mistakes in mind, and you might just be able to convince someone to fund your business.
About the Author:
Adam Hoeksema is the Founder of ExecutivePlan and co-founder of StringHub. ExecutivePlan helps entrepreneurs and small business owners write powerful business plan executive summaries in order to raise capital.