How to create a financial forecast for a software development company?

Developing and maintaining an up-to-date financial forecast for your software development company is key in order to maintain visibility on your business’s future cash flows. 

If you feel overwhelmed at the thought of putting together a software development company financial forecast then don’t worry as this guide is here to help you.

We'll cover everything from: the main objectives of a financial forecast, the data you need to gather before starting, to the tables that compose it, and the tools that will help you create and maintain your forecast efficiently.

Let's get started!

Why create and maintain a financial forecast for a software development company?

In order to prosper, your business needs to have visibility on what lies ahead and the right financial resources to grow. This is where having a financial forecast for your software development company becomes handy.

Creating a software development company financial forecast forces you to take stock of where your business stands and where you want it to go. 

Once you have clarity on the destination, you will need to draw up a plan to get there and assess what it means in terms of future profitability and cash flows for your software development company.

Having this clear plan in place will give you the confidence needed to move forward with your business’s development. 

Having an up-to-date financial forecast for a software development company is also useful if your trading environment worsens, as the forecast enables you to adjust to your new market conditions and anticipate any potential cash shortfall. 

Finally, your software development company's financial projections will also help you secure financing, as banks and investors alike will want to see accurate projections before agreeing to finance your business.

What information is used as input to build a software development company financial forecast?

A software development company's financial forecast is only as good as the inputs used to build it.  

If you are creating (or updating) the forecast of an existing software development company, then you mostly need your accounting information, key historical operating non-financial data, and your team’s input on what to expect for the coming years.

If you are building financial projections for a software development company startup, you will need to have done your research and have a clear picture of your competitive environment and go-to-market strategy so that you can forecast sales accurately.

For a new venture, you will also need a precise list of the resources needed to keep the software development company running on a day-to-day basis and a list of the equipment and expenditures required to start the business (more on that later). 

Let's now take a closer look at the elements that make up your software development company's financial forecast.

The sales forecast for a software development company

From experience, it is usually best to start creating your software development company financial forecast by your sales forecast.

To create an accurate sales forecast for your software development company, you will have to rely on the data collected in your market research, or if you're running an existing software development company, the historical data of the business, to estimate two key variables: 

• The average price 
• The number of monthly transactions

To get there, you will need to consider the following factors:

Once you have an idea of what your future sales will look like, it will be time to work on your overhead budget. Let’s see what this entails.

The operating expenses for a software development company

Once you know what level of sales you can expect, you can start budgeting the expenses required to operate your software development company on a daily basis.

Expenses normally vary based on how much revenue you anticipate (which is why, from experience, it is always better to start your forecast with the topline projection), and where your business is based. 

Operating expenses for a software development company will include some of the following items:

This list will need to be tailored to the specificities of your software development company, but should offer a good starting point for your budget.

What investments are needed to start or grow a software development company?

Once you have an idea of how much sales you could achieve and what it will cost to run your software development company, it is time to look into the equipment required to launch or expand the activity.

For a software development company, capital expenditures and initial working capital items could include:

Again, this list will need to be adjusted according to the specificities of your software development company.

The financing plan of your software development company

The next step in the creation of your financial forecast for your software development company is to think about how you might finance your business.

You will have to assess how much capital will come from shareholders (equity) and how much can be secured through banks.

Bank loans will have to be modelled so that you can separate the interest expenses from the repayments of principal, and include all this data in your forecast.

Issuing share capital and obtaining a bank loan are two of the most common ways that entrepreneurs finance their businesses.

What tables compose the financial plan for a software development company?

Now let's have a look at the main output tables of your software development company's financial forecast.

The projected profit & loss statement

The projected profit & loss shows how profitable your software development company is likely to be in the years to come.

For your software development company to be financially viable, your projected P&L should ideally show:

• Sales growing above inflation (the higher the better)
• Profit margins which are stable or expanding (the higher the better) 
• A net profit at the end of each financial year (the higher the better)

This is for established software development companies, there is some leniency for startups which will have numbers that will look a bit different than existing businesses.

The projected balance sheet

Your software development company's forecasted balance sheet enables you to assess your financial structure and working capital requirements.

It is composed of three types of elements: assets, liabilities and equity:

• Assets: represent what the business owns and uses to produce cash flows. It includes resources such as cash, equipment, and accounts receivable (money owed by clients).
• Liabilities: represent funds advanced to the business by lenders and other creditors. It includes items such as accounts payable (money owed to suppliers), taxes due and loans.
• Equity: is the combination of what has been invested by the business owners and the cumulative profits and losses generated by the business to date (which are called retained earnings). Equity is a proxy for the value of the owner's stake in the business.

The projected cash flow statement

A projected cash flow statement for a software development company is used to show how much cash the business is generating or consuming.

The cash flow forecast is usually organised by nature to show three key metrics:

• The operating cash flow: do the core business activities generate or consume cash?
• The investing cash flow: how much is the business investing in long-term assets (this is usually compared to the level of fixed assets on the balance sheet to assess whether the business is regularly maintaining and renewing its equipment)?
• The financing cash flow: is the business raising new financing or repaying financiers (debt repayment, dividends)?

Cash is king and keeping an eye on future cash flows is imperative for running a successful business. Therefore, you should pay close attention to your software development company's cash flow forecast.

If you are trying to secure financing, note that it is customary to provide both yearly and monthly cash flow forecasts in a financial plan - so that the reader can analyze seasonal variation and ensure the software development company is appropriately capitalised.

Which tool should you use to create your software development company's financial projections?

Building a software development company financial forecast is not difficult provided that you use the right tool for the job. Let’s see what options are available below.

Using online financial forecasting software to build your software development company's projections

The modern and easiest way is to use an online financial forecasting tool such as the one we offer at The Business Plan Shop.

There are several advantages to using specialised software:

• You can easily create your financial forecast by letting the software take care of the financial calculations for you without errors
• You have access to complete financial forecast templates
• You get a complete financial forecast ready to be sent to your bank or investors
• You can easily track your actual financial performance against your financial forecast, and recalibrate your forecast as the year goes by
• You can create scenarios to stress test your forecast's main assumptions
• You can easily update your forecast as time goes by to maintain visibility on future cash flows
• You have a friendly support team on standby to assist you when you are stuck
• It’s cost-efficient and much cheaper than using an accountant or consultant (see below)

If you are interested in this type of solution, you can try our projection software for free by signing up here.

Calling in a financial consultant or chartered accountant

Outsourcing the creation of your software development company financial forecast is another possible solution.

This will cost more than using software as you can expect as your price will have to cover the accountant’s time, software cost, and profit margin.

Price can vary greatly based on the complexity of your business. For a small business, from experience, a simple three-year financial forecast (including a balance sheet, income statement, and cash flow statement) will start at around £700 or $1,000. 

Bear in mind that this is for forecasts produced at a single point in time, updating or tracking your forecast against actuals will cost extra. 

If you decide to outsource your forecasting:

• Make sure the professional has direct experience in your industry and is able to challenge your assumptions constructively. 
• Steer away from consultants using sectorial ratios to build their client’s financial forecasts (these projections are worthless for a small business).

Why not use a spreadsheet such as Excel or Google Sheets to build your software development company's financial forecast?

Creating an accurate and error-free software development company financial forecast on Excel (or any spreadsheet) is very technical and requires both a strong grasp of accounting principles and solid skills in financial modelling.

Most entrepreneurs lack the expertise required to create an accurate financial forecast using spreadsheet software like Excel or Google Sheets. As a result, it is unlikely anyone will trust your numbers.

The second reason is that it is inefficient. Building forecasts on spreadsheets was the only option in the 1990s and early 2000s, nowadays technology has advanced and software can do it much faster and much more accurately. 

This is why professional forecasters all use software. With the rise of AI, software is also becoming smarter at helping us detect mistakes in our forecasts and helping us analyse the numbers to make better decisions.

Finally, like everything with spreadsheets, tracking actuals vs. forecasts and updating your forecast as the year progresses is manual, tedious, error-prone, and time-consuming. Whereas financial forecasting software like The Business Plan Shop is built for this.

Use our financial forecast templates for inspiration

The Business Plan Shop has dozens of financial forecast examples available.

Our templates contain both a financial forecast and a written business plan which presents, in detail, the company, the team, the strategy, and the medium-term objectives.

Our templates are a great source of inspiration, whether you just want to see what a complete business plan looks like, or are looking for concrete examples of how you should model financial elements in your own forecast.

Takeaways

1. A financial forecast shows expected growth, profitability, and cash generation metrics for your software development company.
2. Tracking actuals vs. forecast and having an up-to-date financial forecast is key to maintaining visibility on your future cash flows.
3. Using financial forecasting software is the modern way of creating and maintaining financial projections.

We hope that this guide helped you gain a clearer perspective on the steps needed to create the financial forecast for a software development company. Don't hesitate to contact us if you have any questions!

Also on The Business Plan Shop

• Financial forecast example
• How to write a business plan for a software development company
• How to project revenues for a business?
• Financial forecast for a business idea

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