Be Conservative in Projecting Income, Margins and Costs

Before I started my first business many years ago, I did some financial projections. I worked out 3 possible scenarios for the internet cafe venture that was planned. They were the best, expected and worst case scenarios. The projections showed the internet cafe business to be viable even in the worst case scenario. With that, I confidently embarked on my first startup.

After operating for several months, I realized that my financial projections were way too optimistic. In fact, the best days that the internet cafe had were closer to the worst case scenario in my financial projections.

This brings me to this week’s topic. We human beings tend to be overly optimistic especially when our intentions are to start a business venture. Of course, the advantage of being optimistic is that it gives us hope to persevere with the aim that things would improve and work out in the end. However it would be good if one is prepared for situations where things do not work out as planned.

One major cause for over optimism is the overstating of profit margins. I went through the topic of profit margins in some length in my earlier posts. Say you are able to purchase a category of goods for sale at 30% of the selling price. It would be a mistake when doing the financial projections to state that the cost would be 30% of the sale price.  You can read the reasons at Don’t Count the Profits Until All the Stocks are Sold and What are the Profit Margins for your Products?. Thus a more conservative estimate of the profit margin could be 50% or even less.

Another cause of over optimism lies in the over estimation of the quantities that could be sold at the stated selling price. It is possible that the quantities that you expected to be sold could only be achieved at a lower price. However, for the price that you wanted, the quantities that could be sold would fall far short of expectations.

Over optimism also extends to other areas like rental and cost of employing workers. Perhaps the rent for the premises you expected to pay would result in a less favorable location that you desired. Insisting on the desired location could put the asking rent for the premises way above what you anticipated. The same goes for good employees.

In  conclusion, it would be better to be more conservative when doing your financial projections for the start up. Perhaps a good way would be to do the 3 scenarios stated earlier, the best, expected and worst case scenarios. Then throw out the best case scenario as unrealistic, rename the expected case as best case and the worst case as expected case. Then do another worst case scenario which is even more pessimistic than the earlier one. That to me would be a more realistic financial projection.

You can always do your financial projections using the free Android StartBizUp App.

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