But Aren’t Financial Projections Always Wrong Anyhow?

It’s a common question: Why bother with financial projections? After all, they are never right, almost always inflated, and generally a waste of time. Right? Do investors even read them? And if so, why?

I saw a great answer to that question in Pitching a VC: Why Financials Matter, posted earlier this month by David Hornik on his Ventureblog. David is a very well known venture capitalist, a partner in August Capital.

Here’s what he says:

It is well understood by entrepreneurs and VCs alike that the specific numbers an entrepreneur pitches when describing her early stage business are completely made up.

Most early stage CEOs are lucky to have visibility into the next 6 months, let alone the next 3 year that are reflected in their financials and the 5 year forecast is mere fortune telling.

Nonetheless, there is a huge amount of information about a business, and about an entrepreneur, that is reflected in those financials. The key is not to focus on the numbers themselves but, rather, to focus on the assumptions in those projections and the points of leverage for that business.

Well said. I agree. And to add some specific examples:

• I hate the high growth rates that aren’t built on detailed assumptions. Hockey stick sales forecasts are cool when they’re based on some justifiable logic. Otherwise, they just hurt credibility.
• I hate unrealistic profitability. They’re almost always evidence of sloppy thinking or not understanding the expenses. In those rare cases where they can be possible, I say that if a business is that profitable, spend more on marketing and grow it faster.
• I always look for marketing expenses as a percent of sales, and headcount and personnel costs, and compensation for management. Reasonable estimates on these points add to credibility.
• I also look for how the projections deal with working capital to finance receivables and inventory, if those are relevant.

So please, show me the numbers. I won’t expect them to be right, but I will expect them to be credible, reasonable, and tied together correctly.

All opinions expressed are those of the author,  and do not necessarily represent those of Gust.