Forecast or Projection – Which is it?

Aug 17, 2020 by Roger Scherping

What’s the difference between a forecast and a projection? I know that I often use those terms interchangeably. Does anyone care? Does it even matter?

Yes, it does matter, or at least it can. There is a subtle but significant difference between a forecast and a projection. It probably won’t matter too much for your internal discussions, but if you’re talking to a professional like a banker or a potential investor, you should be clear on whether you’re presenting them with a forecast or a projection.

FINANCIAL FORECAST

A financial forecast involves taking your best guess at what your revenues, expenses and cash flow will be for a period of time and determining what you expect your balance sheet to look like at some point in the future. When you do a financial forecast, you’re taking what you know about your business, the expected economic climate, and your planned business decisions and rolling all that into a picture of where you think your business will be at some point in the future. This is you taking into consideration everything that you can think of to make an educated guess at what your financial future looks like.

There are several reasons you might want to do a financial forecast. You may be in a time of severe financial uncertainty (think 2020). Decision making becomes difficult when you don’t know what’s going to happen. So rather than making decisions blindly, you can extrapolate from where you are today and figure out your best guess as to the trend that you are currently on. This look ahead will tell you the changes necessary for a course correction that will turn things around and strengthen your financial future.

Too many companies just operate from day to day without stopping to think ahead. They just concentrate on what they must do to get their orders out by Friday. There’s an expression that you can’t achieve your future without envisioning it first. A financial forecast will help you understand where you want to be and then lay out a path to get you there. It will show you whether you need to start now to look for a bank loan, or whether you can afford to hire another sales person, or whether you had better plan now to put some additional money into your business to cover an anticipated cash shortfall. Once you have a plan that will work, then you can concentrate on executing that plan.

Financial forecasts are also necessary if you are looking to borrow money from a bank or find someone to invest in your business. You need to be able to communicate to these professionals what your financial future looks like. They need to see a credible financial forecast that answers their questions about future sales, profits and cash flow, so your financial forecast is a critical part of getting a loan or additional equity for your business.

FINANCIAL PROJECTION

OK, that’s a forecast. So what’s a financial projection? A financial projection is the same as a financial forecast in that it presents a picture of the financial future of your business. But a financial projection is not necessarily the most likely picture of where you think your business will be at some point in the future. It is a look forward, but it’s one that incorporates different hypothetical decisions that you might make with the business or possible economic conditions that are not necessarily the most likely.

Very simply, a financial projection is a “what if” analysis. It might present one or more hypothetical courses of action that the business might follow.  What if sales drop 10% or 25%? What if we launch that new product line? What if we borrow enough money to acquire our competitor? A financial projection is typically used for internal discussions and decision making.

Financial projections help you look before you leap. Before you make that big, bold move, what will it do to your profits? Your cash flow? Wil it require a loan or additional investment? How long will it take to start turning a profit?

Financial projections are how you model the future to extrapolate and see how your planned decisions might play out. You can compare different sets of assumptions and see which one works the best. Maybe you even determine NOT to go ahead with your big, bold idea. It’s far better to figure out on paper that it won’t work than to figure it out months later after you have invested capital that you’ll never get back or lose enough money to jeopardize your company’s future.

WHY YOU NEED TO UNDERSTAND YOUR COMPANY’S FINANCIAL FUTURE

Financial forecasts and financial projections can help you successfully meet the challenges of running a small business:

- Guide your decision making
- Extrapolate the path you’re currently on
- Model the potential results of various business decisions
- Elevate your thinking above the day-to-day and envision your company’s future
- Attract bankers or investors


HOW TO CREATE FINANCIAL FORECASTS AND FINANCIAL PROJECTIONS

A financial forecast or projection requires three things:

1. Some financial history for comparing your forecast against recent past for assessing reasonableness
2. A budget of what you think your future income, expenses and profit look like
3. Decisions on things like equipment purchases, cash receipts, inventory purchases, and capital investment

Most financial people will tell you that you need to find or create a spreadsheet that will roll up all of your decisions and create your forecast or projection for you. Not true!

ProjectionSmart has created the simplest way to do a forecast or a projection. Our Growth tool is for existing businesses, and by using Growth the owner of a small existing business can easily create a 12-month forecast or projection.

Growth completes the three steps for doing a forecast or projection like this:

1. History: We import your financial history directly from QuickBooks Online. If you don’t use QuickBooks Online, you can enter your history manually.

2. Budget: You enter a simple budget showing your expected sales, gross margin and net income for the next 12 months. If you want, you can even copy your prior 12 months, use that as a starting point for your budget, and make any necessary adjustments.

3. Questions: Growth walks you through the last step in the forecast or projection process by simply asking you questions about your plans for your business. Do you plan to buy any equipment in the next 12 months? Do you have to pay any debt? Do you plan to take any money out of the business? We will also make some assumptions for you on cash receipts and payments and inventory purchases, but you are free to change them as necessary.

That’s all it takes! Then you can review the seven key financial graphs and the three financial statements to see the results of your decisions. And if you don’t like the results, you can simply change any of your assumptions, and all of the graphs and financial statements change automatically, making Growth entirely interactive.

With your financial forecast using Growth, you have your best-guess as to what the next 12 months look like for your company. But that’s not all. You can also do a financial projection with Growth by using our versions feature.

Growth allows you to create three different models of your financial future. Maybe the first one is your best-guess version that you could share with your banker. Then version 2 might be your optimistic or best-case projection, and version 3 might be your optimistic or worst-case projection. This is called a sensitivity analysis, and it shows you a range of expectations that your business might experience so that you can be prepared for them.

Our you could use versions 2 and 3 to model two different sets of business decisions and help you choose the better course. Maybe you are considering a new product line or an acquisition and want to see what the likely outcome is of these decisions. Growth would give you a set of financial projections that you would probably use for internal decision making.

However you use Growth, for a forecast or for a projection, you’ll find there is no better tool for the small business owner who lacks a finance or accounting background. We take care of all of the accounting work for you. You do not need a spreadsheet or an accounting degree. You just follow our simple process, and you will find that your financial future has never been more clear.

Email me if you have any comments.

Roger


 

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