Potential investors are only looking to choose the best companies possible to invest in. As a result, they rely on calculated risk taking in order to determine which bets are likely to deliver returns. The preparation of financial projections by your company allows investors to analyze your startup’s management team, business model, assumptions, and understanding of the cannabis market.
Investors can gather a lot of information from your financial projections and they use them to determine whether your assumptions about the future performance of your business are sensible and if there are actually justifications for such projections within your business plan.
To help you get started, here is a general overview of how financial projections for cannabis related startups are prepared so that investors take your business seriously.
What Documents Go Into Financial Projections?
The three main documents that are used to prepare financial projections are:
In order to draw up these statements, you need to know the income and expenses for your business.
What Costs Should Cannabis Businesses Include in Financial Projections?
If you're seeking financing for your cannabis business, financial projections are essential for convincing lenders and investors that your business plan is viable and that your business will offer them a good return if they decide to invest in your business.
In addition, many business owners are often confused about how to draw up financial projections for the purposes of a business plan because of the fact that they are forward-looking statements and have virtually nothing to do with the historical performance of your business.
To help you understand how financial projections are developed for cannabis businesses, here are the costs that cannabis businesses should include in their financial projections and how assumptions are used in financial projections.
Include Both Variable and Fixed Costs
Here are the costs that you should include in your cannabis business financial projections.
In general, it is recommended that you draw up financial projections that extend three to five years into the future. In addition, some of the costs that you include in your financial projections will be fixed costs while others will be variable costs.
Variable costs are those costs that will fluctuate as your business matures, such as inventory. Fixed costs are those costs that are unlikely to change, such as debt at a fixed interest rate. It is the variable costs that you’ll need to take care with to ensure that your financial projections are indeed realistic.
How to Collect This Information
At its core, creating financial projections is more of an art than it is a science. That is because you are basically making educated guesses about the future performance of your business. In reality, you have no idea what the future has in store for your business. In addition, you just may find that things don't go as planned or the growth of your business actually ends up exceeding your expectations.
Therefore, your financial projections will be based on assumptions. Assumptions are not arbitrary. In fact, they are based on specific formulas. If your business has historical financial statements available, then you can use these in order to identify the formulas to use for your financial project assumption. However, for startups that do not have historical data, many accountants choose to refer to financial statements from approved sources.
EDGAR is a research tool that enables accountants to search the operations data of publicly traded companies. This is one way to obtain relevant financial information so that the financial assumptions used by these companies can be used in the preparations of financial projections for your own startup.
While some information can be gathered solely by using the details of other businesses, some costs will be unique to your business. Therefore, the costs included in your financial projections will likely be a combination of data from established companies and your company’s own data.
How Assumptions Are Used in Financial Projections
Once you’ve obtained the costs that you’d like to include in your financial projections, you’ll also need to make sure that your assumptions tie into the other details that you’ve provided in your business plan, if your goal is to obtain funding for your business. Regardless of your purpose for drawing up financial projections, your assumptions need to be reasonable if you want them to have real value for forecasting the future of your business.
If you're not clear on how to ensure that your financial projections are realistic, you should hire an accountant. An accountant that has experience in the cannabis industry can help you identify the characteristics of a successful, well-run cannabis business. An accountant with cannabis industry experience can also help you to effectively map the future performance of your business to established companies and can recognize the potential concerns that are unique to businesses in your industry.
Use Financial Projections As a Guide for Your Business
You may be interested in drawing up financial projections for your business solely because you want to attract investors. However, the most important reason for doing this is so that you can obtain a better understanding of how your business will do.
Use the details of these financial projections as a guide for running your business. Have financial projections drawn up periodically so that you can always have them available to get insights into the future health of your business.
Even if you aren't pursuing financing, you still need financial projections to plan for the future of your budget. Financial projections help you to budget and the serve as a way to measure the future success of your business, allowing you to identify areas for improvement.
One important thing to note here is that these documents are not the financial statements that you use to prepare your taxes. These documents are actually forward-looking statements while the income statement, cash flow statement, and balance sheet that you use to to do your taxes are historical-looking statements.
As a result, financial projections depend solely on the data that you choose to include in them. Given this fact, it is important that you prepare them carefully in order to avoid gross inaccuracies.
Have Financial Projections Prepared By a Third-party
If the purpose of creating financial projections for your company is to raise capital, you must have them prepared by a third-party. This ensures that your financial projections are free from fraud and the undue influence of company employees and management.
In addition, your financial projections must also be reliable in order for them to be considered of value to potential investors. This is because financial projections are based on assumptions. These assumptions aren’t just made up ideas about what you think will happen to your business in the future.
Assumptions are actually drawn up from financial data of established companies and the historical data of your own business, if available. An accountant will use set formulas to determine the values of specific assumptions in your financial projections.
In addition, financial projections also project your sales and establish expense budgets for your business. In this way, you'll automatically know that if your business is falling behind the financial projections, you need to make some changes to keep your startup afloat. On the other hand, if your business grows faster than expected, you must then put the contingency plans specified by your business plan into action so that your business can adjust accordingly.
What If Your Business Isn’t Started Yet?
If your business isn't actually up and running yet, it's even more challenging to figure out what your income and expenses will be years from now. To help you figure things out, use the market research that you used to develop your current business model. If there are other businesses in the cannabis industry that are similar to yours, look for publicly available information about these businesses.
Just because your business isn't started, that doesn't mean that financial projections are useless. In fact, when done by a professional, they can paint a realistic picture of what your business will look like a few years after it has been established, provided that no unforeseen disruptive events take place.
Projecting Future Profitability for Your Cannabis Startup
For cannabis startups, financial projections generally are designed to project three to five years into the future. This will allow you to see the point at which your business starts to turn a profit. For the cannabis industry, many businesses take years to break even, given the myriad of obstacles that cannabis businesses face.
With delays in achieving growth ranging from federal and state regulatory requirements to licensing, patents, and facility setup, financial projections can actually help you to overcome misplaced optimism about the immediate success of your business. With financial projections, you’ll have a more accurate picture of how the growth of your cannabis startup will look.