Creating Projected Financial Statements: Essential Elements, Components and Best Practices

Introduction

Projected financial statements are an important tool used by businesses to plan for the future. These statements provide an estimate of how the business’s financial performance is expected to look in the coming months or years. They can be used to create budgets, assess risks, and make strategic decisions. This article will explore the essential elements, components, and best practices for creating projected financial statements.

Essential Elements of a Projected Financial Statement

A projected financial statement includes three primary documents: an income statement, balance sheet, and cash flow statement. The income statement reflects the business’s revenues and expenses over a given period of time. The balance sheet reports the assets, liabilities, and equity of the company. The cash flow statement shows the cash inflows and outflows from operating, investing, and financing activities.

Key Components of Each Financial Statement

The components of each financial statement are as follows.

Income Statement

The income statement is composed of the following components:

• Revenues – The amount of money earned by the business during the accounting period.
• Expenses – The costs associated with generating revenue such as labor, materials, and overhead.
• Net Income (or Loss) – The difference between revenues and expenses.

Balance Sheet

The balance sheet is composed of the following components:

• Assets – Anything owned by the business that has value such as cash, accounts receivable, inventory, and property.
• Liabilities – Debts or other obligations owed by the business such as accounts payable, loans, and taxes.
• Equity – The difference between assets and liabilities; it represents the owner’s interest in the business.

Cash Flow Statement

The cash flow statement is composed of the following components:

• Operating Activities – Cash generated or used from the normal operations of the business.
• Investing Activities – Cash generated or used from the purchase or sale of assets.
• Financing Activities – Cash generated or used from obtaining capital or paying back debt.

Preparing a Projected Financial Statement

To prepare a projected financial statement, you will need to gather data and make assumptions about the future. You should begin by gathering historical financial data such as income statements, balance sheets, and cash flow statements. This data can be used to identify trends and gain insight into the past performance of the business. Additionally, you should research industry trends and market forecasts that could impact the business in the future. Government statistics can also be used to understand the economic environment in which the business operates.

Once you have gathered the necessary data, you can begin constructing the projected financial statements. To do this, you will need to make assumptions about the future. For example, you may assume that sales will increase by 10% next year or that expenses will decrease by 5%. These assumptions should be based on the data you have collected and should be realistic and achievable. You should also establish validation criteria to ensure the accuracy of your projections.

Once you have constructed the projected financial statements, you should verify their accuracy. This can be done by comparing the actual results to the projected results. If there is a significant difference, you should adjust your assumptions accordingly. Additionally, it is important to effectively communicate the projected financial statements to stakeholders. This can include providing an explanation of the assumptions and how they were derived.

Finally, you should consider any potential risks associated with the projected financial statements. For example, if the projections are overly optimistic, the business may not be able to achieve them and could suffer losses as a result. It is important to consider these risks before finalizing the projections.

Sources of Data for Constructing a Projection

When constructing a projected financial statement, it is important to use accurate and reliable data. There are several sources of data that can be used to create a projection, including the following.

• Historical data – Historical financial data can be used to identify trends and gain insight into the past performance of the business.
• Industry trends – Researching industry trends can provide information about the direction of the industry and what to expect in the future.
• Market forecasts – Market forecasts can provide information about the overall economic environment and the direction of the market.
• Government statistics – Government statistics can provide information about the macroeconomic environment in which the business operates.

Making Realistic Assumptions in the Projections

It is important to make realistic assumptions when creating a projected financial statement. This means that the assumptions should be based on the data you have collected and should be achievable. Additionally, you should establish validation criteria to ensure the accuracy of the projections. This can include comparing the actual results to the projected results and adjusting the assumptions accordingly.

Best Practices for Validating and Communicating the Projected Financial Statements

Once you have created the projected financial statements, it is important to validate their accuracy and communicate them effectively. To do this, you should verify the accuracy of the projections by comparing the actual results to the projected results. Additionally, you should provide an explanation of the assumptions and how they were derived. Finally, you should consider any potential risks associated with the projections and take steps to mitigate them.

Conclusion

Projected financial statements can be an invaluable tool for businesses to plan for the future. To create a successful projection, it is important to use accurate and reliable data, make realistic assumptions, and follow best practices for validation and communication. By following these guidelines, businesses can create effective projected financial statements that can be used to make informed decisions.