Financial projections are a crucial part of any business plan. They’re an estimate of future revenue, expenses, and profits. However, the confidence with which entrepreneurs make these projections can have a significant impact on the success or failure of their venture.
Let's review the merits of confidence in financial projections and the potential risks of being overly optimistic.
Entrepreneurs are expected to be confident in their ability to execute their business plan successfully. Confidence in financial projections is essential when seeking funding from investors or lenders. It demonstrates that the entrepreneur has a clear understanding of their business and has thought through the potential challenges and opportunities. It is also a sign that the entrepreneur is committed to achieving their goals and has a solid plan in place to do so.
However, there is a fine line between confidence and overconfidence. Entrepreneurs who are overly optimistic about their financial projections may be setting themselves up for failure. This is because they are not basing their projections on realistic assumptions and are instead betting on best-case scenarios. This frequently leads to a lack of contingency planning and the inability to adapt when things don’t go as planned.
One danger of overly optimistic financial projections is that they can lead to a false sense of security. Entrepreneurs may become complacent and fail to take the necessary actions to mitigate risks or capitalize on opportunities. They may also be less likely to seek advice or guidance from experienced professionals, as they believe they already have everything under control.
Another, more serious consequence is deterioration in the relationship and trust between founders and early investors in the case of “down-rounds”, frequently resulting in replacement of the founders, with professional leadership.
Even when the reaction to missed forecasts is less severe, the relationship could be changed forever, with a view that these are “promises that have been broken”. Far better then, to over-deliver on promises.
Sadly, but not surprisingly, bullish over confidence seems to be the predominant posture of entrepreneurs, more-often leading to a breakdown in trust and deteriorating relationships between entrepreneurs and their early-stage investors along with down-rounds that have lower valuations for future investor groups. A further consequence can be changes in leadership, enforced by investors, once confidence and trust is eroded. Everyone loses, but mostly, the founders.
In contrast, entrepreneurs who are more cautious in their financial projections are far more likely to be successful. They are more likely to base their projections on realistic assumptions, consider potential risks and challenges, and have contingency plans in place. This approach may be less exciting or glamorous than making bold projections, but it is more likely to lead to long-term success.
What our experts say
“There is strong evidence that entrepreneurs are overly confident when dealmaking and that when a deal is made based upon an over-confident mindset, there is a danger of correlating with the 80% of new ventures that fail rather than the 20% that succeed. Failure meaning the forecasted outcomes don’t happen. When you place a bet on the future, you are not betting on what you know, but on what you don’t know. So, rather take a leaf out of the financial expertise book and hedge against the downside risk. Better to work within the confines of what is known, than what might be expected, or worse, what is hoped for. ”
Malcolm Buxton Ph.D.
Adjunct Professor, The Chicago School of Professional Psychology
“The older a company a company is, the better and more boring are their financial projections. Said another way, early stage companies generally do the most exciting but of poorest projections, because their forecasts are brightly coloured with imaginations and aspirations. Not a bad thing of course, but these should be tagged with a ‘creative’ discount rate; less mature company’s forecasts are ,well, certainly more poetic. Filled with hopes and dreams. But these are generally not things that one can rely on. Except sometimes, and therein the art of investing.”
Professor Steven Sidely
Director – Bridge Capital Future Advisory, Professor of Practice – JBS, University of Johannesburg
