What Is a Projection Model and Why Is It Needed for an SBA Loan?
Author: Elliott Holland
A projection model is crucial for an SBA loan application when looking for funding to buy a business. Learn why it's needed and how to go about it.
Key Takeaways:
SBA loans are partially guaranteed by the government and can work for people with high default risk
A projection model includes forecasts of the business’s cash flows, income, and balance sheet
Here are five ways to include a projection model in your SBA loan application
Loans from the U.S. Small Business Administration (SBA loans) are often a great funding option for first-time buyers and self-funded searchers. If you need funding to buy a business, you'll need to create a solid business plan that includes a projection model. Read on to learn why you’ll need to include a projection model in your application if you’re applying for an SBA loan.
What is an SBA loan and who gets them?
SBA loans are a type of loan offered by financial institutions and are partially guaranteed by the U.S. government. The U.S. Small Business Administration created these loans to improve access to capital for small businesses. The government guarantee means banks and other lenders are less reluctant to offer these loans to people with higher default risk. That’s because if you can’t pay back what you borrow, the lender can get a certain amount of its money repaid by the government.
Using an SBA loan to buy a business
There are several SBA loans on the market. The most popular one is the SBA 7(a) loan. It has long repayment terms, low interest rates, and flexible closing costs. Plus, it can help you cover expenses associated with buying a business.
SBA loan application criteria are stringent, even if you qualify. You will still need to provide supporting documents with your application. One of these documents is your set of financial projections for the business, commonly called a projection model.
What is a projection model?
For entrepreneurs looking for funding, a projection model is crucial. A projection model, or financial projection, is what a business expects to happen based on hypothetical circumstances using data and facts. These are also called financial forecasts of your income statement.
Why are projection models important?
A projection model is part of the loan process, and lenders will ask you for a financial plan. Some lenders or investors may ask for more details than others, but building a projection model is wise and will help you answer any tricky questions a lender has. Plus, financial statements offer an opportunity for evaluation in the future if the business ever becomes a target for acquisition.
Through projection, you can alter production plans, change pricing, and monitor cash flow. You can also see when you might have financial needs and the best time to make capital expenditures.
Which financial projections do you need to apply for an SBA loan
It’s wise to have three financial statements prepared for a business loan application:
A cash flow statement, typically month-to-month cash flow projections for at least one year
An income statement (also called a profit and loss statement)
A balance sheet
Essentially, you are required to produce financial forecasts of your profit and loss and cash flow statement for at least 12 months. These documents are used to answer questions about what you will do with the money if lent to you and how you plan to repay it.
The balance sheet isn't strictly necessary, but you still need to project details like working capital and other cash flow movements that will affect the balance sheet. While you'll be required to produce forecasts for 12 months, due diligence advises that you prepare a 36-month forecast for small businesses that have little financial performance and assets as they have higher default risk.
Why you should include a projection model with your SBA loan application
To start the loan process, contact a lender to help you get started. The paperwork and jargon can be overwhelming, but personalized guidance can make the process easy for you. Here is a five-step list to help you build a solid projection model to include in your SBA loan application.
1. Project your variable and fixed costs
Variable costs go up or down based on changing sales numbers and other expenses related to corporate taxes, raw materials, advertising, transportation, and packaging. Fixed costs are easier to project, as they remain the same over time. These include salaries, rent and utilities, bank fees, and web hosting.
2. Identify your revenue streams and create a revenue model
First, identify your revenue streams, which are the ways the business makes money. Once this is done, build out a revenue model around these. Remember, revenue has at least two drivers: price and volume.
3. Consolidate revenue and costs
Next, put it all together in your profit and loss statement. Subtract all expenses (variable and fixed), plus any other startup costs to get net profit. Calculating your cash flow statement at this stage shouldn't be too complicated: just subtract any cash items, like cash expenditures, from your net profit. You can calculate these numbers using a spreadsheet or other accounting tools.
4. Create contingencies
It can be helpful to include different scenarios – best, likely, and worst – to help you plan for each. A contingency plan helps your new business if an unexpected event throws off your projections.
5. Review and adjust
After preparing your forecasts, take a little time to review your estimates and see if they make sense. Check for errors and decide if they are realistic. You can also compare your projections with industry averages to make them more realistic for your new business.
Let us help prepare a rock-solid projection model
When looking forward to buying a business, you may have ideas about where to source funding. The main option is to get a loan, as it is often easy to access and relatively straightforward. A well-built projection model can help you make sense of the metrics and also help you secure an SBA loan to acquire that business.
The guidance of an expert can give you the support you need to prepare solid projections and get funding. At Guardian Due Diligence, we can support you throughout the loan application process and guide you in building your own projection model. Contact us to schedule a call today.