Financial Modeling & Business Planning > Pitfalls & Dangers
The veracity and usefulness of financial projections will be completely determined by the quality and reliability of the underlying assumptions. For example, if sales or cost forecasts are unrealistic or inadequately researched, then the value of a model's output is greatly diminished.
An impressive set of financial projections is of little benefit if unsupported by research or simply based on speculation or wishful thinking.
When preparing financial projections, be conscious of the following pitfalls and dangers:
| • | Using financial forecasting as a substitute for business planning |
| • | Ignoring historic trends at business, sectoral and national levels |
| • | Overstating market shares and growth, sales forecasts, and profit levels |
| • | Underestimating costs and delays likely to be encountered |
| • | Disregarding industry performance norms and competitors' responses |
| • | Breaching generally-accepted financial guidelines and ratios |
| • | Making unduly optimistic assumptions about the availability of loans, trade credit, equity etc. |
| • | Seeking spurious accuracy while ignoring matters of strategic importance. |
These problems can arise as the result of a lack of foresight or insight, or due to excessive optimism. Because they can lead to under-estimation of the resources required to develop a business with potentially disastrous consequences, it can be completely counterproductive to overstate the potential of a business.
There is often merit in compiling worst case projections to complement most likely or best forecasts. Exl-Plan can be used for sensitivity-analysis (See Doing Sensitivity Analyses).
The bottom line is that realistic views should always be taken of a business's prospects, prospective profits, funding requirements etc.
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