Financial projections are three to five year projections of your:
- Balance Sheet
- Income Statement
- Changes in Cash Flow
The Balance Sheet reports what assets you have, on the one hand, and what debts, equity, and retained earnings you have. Debts, equity, and retained earnings can be thought of as the sources of the money you used to obtain all your assets – the two (the assets versus the debts, equity, and retained earnings you used to obtain your assets) have to be equal, hence the name “Balance Sheet”.
The Income Statement
The Income Statement shows your revenues and your expenses. Some of the expenses (like depreciation) are not actual cash expenses. Depreciation represents the fact that the value of many kinds of assets depreciate over time.
And remember that revenue is different from cash. In accrual accounting (probably what you’ll have to use) revenue is recognized when you ship a product to your customer. That customer may well pay you months after you’ve shipped the product. Because of that, cash-in often trails revenue.
Changes in Cash Flow
Cash is the single most important financial measure for a start-up. When cash is gone, it’s game-over. So it’s critical to:
- Always know your cash position
- Always have at least 6 months of cash runway
The only way you know if you have 6 months of cash runway is to do a cash flow projection, and to keep it up to date. Likewise, the only way you know how much money you need in a funding round is to do a cash flow projection.