Projecting Financials: The First Step

Gathering Historical Information

The first place to look when projecting future financial information is at your own historical financial statements. Since history often repeats itself, you can rely on these statements to help build and validate your budget. Even if you plan significant changes, the information from past financial successes, and even failures, can provide a starting point for your estimates. Since the most helpful information is the most recent information, it is best to have the three most current years of useful, accurate historical data.

Collecting useful historical financial data is not always easy. You may not trust the historical financial information available, or you may not have historical figures that support the business functions you are budgeting for. Before you proceed, analyze your situation in Useful Historical Financial Information.

If you are able to check each of the boxes in Useful Historical Financial Information, you can comfortably rely on historical data as a basis to prepare the budget. If not, your historical information may not provide you with the most accurate basis to prepare the budget. Consider how you can use the data and what information might be misleading. For example, if you have start-up information included in your last three years of financial data, you may only use the year(s) of historical data that most reasonably reflects the future direction of the company. You can always use the other information on an account-by-account basis to pinpoint specific costs, such as telephone or rent.

Useful Historical Financial Information

Before you base your financial plans on your most current three years of historical financial data, check to see that the following is true:

Financial statements were prepared on a regular basis.
Financial statements were prepared or reviewed by a competent accountant.
The business strategies for the last three years were similar to the future strategies.
No one-time, large expenses or sales were recorded in the last three years that would skew the financial information.
The accounting system is trustworthy and has been the same for at least the last three years.
None of the last three years of financial data is considered part of the company’s original start-up phase.

Researching Other Businesses

Financial research can help you adjust your historical data to include new aspects of your vision and business strategy. The changes you will make to the budget based on historical data, should be verified by researched facts.

Many trade associations provide industry information that can be built into financial assumptions. Additional industry information appears in the databases of business magazines and journals at most libraries. Under the industry classification codes, the North American Industrial Classification System (NAICS) or Standard Industrial Classification (SIC), articles about existing businesses may mention information about profits, expenses, or other financial data.

Studies of financial statements from similar companies may also provide valuable information. The Securities and Exchange Commission (SEC) has financial information about publicly traded companies online. Also, several publishers collect information from companies and compile it by industry. Using industry classification codes, you can review the financial information of competitors within your industry. Information is organized by the size of the company and includes data concerning sales, expenses, assets, liabilities, equity, and financial ratios. These financial statement studies are available at most libraries. The main publishers of these studies produce the following resources:

RMA Annual Statement Studies – Includes seventeen sections arranged by primary NAICS or SIC code. They contain composite company financial data supplied by Risk Management Association’s member institutions.
Industry Norms and Key Business Ratios, Dun and Bradstreet – Includes financial information based on financial statements of various companies arranged by SIC code.
Almanac of Business and Financial Ratios, Leo Troy, PhD – Provides financial information from IRS data on millions of companies.

Analyzing the Information

After gathering historical and researched financial information, you should prepare a preliminary forecast. This important aspect of the first step to budgeting takes a big picture look at the primary components of profitability—Sales, Cost of Goods Sold, and Operating Expenses. Taking this step prior to developing the detailed line-by-line budget can save a great deal of time and effort. Consider the preparation that a farmer goes through before planting crops. The farmer tests the field’s ability to support the crops by taking soil samples to identify the existing nutrients. Like this farmer, you will want to test how well your existing financial resources support your proposed business strategy. By preparing a preliminary forecast before developing the detailed budget, you can gauge the potential profitability inherent in your strategy.