How can you develop accurate financial projections for clients using analytical reasoning?

Working on more than 100 opportunities each year, I have realized that defining the scope and purpose of financial projections is the first key step. In most cases you would like to project a baseline, however, in some occasions you would like to know a downside case when, for example, you build a model for a risk management purpose. It is also critical to understand the scope. For example, projections to evaluate a target company before and after synergies are totally different. Thus, defining the scope and purpose should come first before preparing a projection for clients.

Developing accurate financial projections for clients requires a combination of thorough research, understanding of historical data, and a keen insight into market trends. Using analytical reasoning allows us to critically assess data points, identify patterns, and make informed predictions about future financial performance. It's essential to remain diligent, continuously update assumptions based on changing circumstances, and always maintain transparency with clients. Leveraging both quantitative analysis and qualitative insights ensures a holistic approach to forecasting.

To define the scope and purpose of financial projections, it is essential to have a common understanding of the business situation of the client. Typically, these projections serve to inform decision-making, necessitating a thorough understanding of the client's existing circumstances. For example, if the client seeks insights specifically on financing structures, while already having operational and investment projections, the emphasis should be on crafting detailed financing calculations. Nonetheless, a review of the existing operational projections remains essential to ensure a comprehensive approach.

Utilizing analytical reasoning to construct financial projections involves scrutinizing data sets, market trends, and forecasting models. For instance, in working with a tech startup, analyzing market growth, user adoption rates, and competitor performance facilitated precise revenue forecasts. This approach fortified their fundraising strategies and informed key investment decisions, ensuring a clearer path toward financial success.

Not only do you need to gather and validate data you need to interpret that data into digestible information that client can understand doing this gives the client more trust and and understanding which propels a better professional relationship

Analytical reasoning on both the data available and unavailable is the only way consultants make financial projections. Three things are of utmost importance here: 1. Gather historical data and analyze the trends. Whats the cash cow and cash burn? Conduct a cost benefit analysis of different units and initiatives. Understand the historical growth trajectory here 2. Benchmark it against the market standard. Do the same exercise for your clients competitors, you can pick up annual reports of the listed competitors for the same or look up news articles 3. Compare the two and understand wheres the gap , what new can be tapped into, what to continue and where to optimize costs. Based on this, you can project the financials

Before gathering the data for your projections, it is important to have a conceptual understanding of your financial model. I suggest using an output-oriented approach, working backwards through the required calculations to understand the data requirements. A high level of detail in your outputs requires also a lot of detail in your data. When you have a good understanding of the data needed for the projections, you should check with your client if reliable data at this level is available. Otherwise, it might be more helpful to reduce the complexity of your forecast.

I would like to highlight three points below: (1) Know modelling best practices. It is important, especially when the model is intended to be used by your clients. There are various rules that you should follow to make your models easy-to-use and easy-to-understand for everyone. (2) Consider client's needs and maturity. For example, you will make a judgement whether you make a model simplified or precise based on the purpose and knowledge of users. (3) Test models a hundred times. 90% of spreadsheets are said to include errors. The combination of reviewing every formula (a bottom-up review) and checking output based on your financial and business understandings (a top-down review) are both important to avoid critical errors.

When creating financial projections, it is most helpful to create a 3-statement-model, integrating: Income Statement, Balance Sheet, and Cash Flow Statement. These financial statements are dynamically linked. Net income from the income statement is a starting point for the cash flow statement, and also affects retained earnings on the balance sheet. The closing cash balance of the cash flow statement is linked back to the balance sheet. If built correctly, assets are always equal to the sum of liabilities and equity. This helps you to get a comprehensive view as it forces you to think about various aspects: What is the effect of revenue growth on working capital? Does an investment generate sufficient cash flow to service debt?

Once you build a robust financial model based on best modelling practices, it is good time to provide recommendations and action plans for your clients. You can run the model under various scenarios and understand the risk and return profile. As such, your recommendations are supported by fact and numbers. One important note is that no one can tell exactly what it will be like in the future. Therefore, it is as important (or even more important) to understand financials and value under various assumptions as to work hard trying to estimate parameters precisely using analytical reasoning. Evaluating a range of possible outcome often results in more "accurate" understanding of the situation.

I would say to develop accurate financial projections for clients, start by thoroughly analyzing their historical financial data and market trends. Use this information to identify key variables affecting their business. Apply analytical reasoning to model different scenarios, considering factors like revenue growth, cost fluctuations, and market shifts. Provide actionable recommendations based on your clients analysis, ensuring they align with their goals. Regularly update projections as circumstances evolve, and incorporate feedback to refine your approach will help.

Are there any technical limitations to consider (e.g. Excel version, use of VBA, Power Query)? Are there any existing projections / business plans that could be used as a starting point? Are there any formal requirements in relation to the projections, e.g. certain KPIs that are required for investment approvals? What is the expected timeline for completion of the financial projects? Who will be using the model and how often is the model going to require updates?