Financial forecasting is a vital skill that many small business owners overlook, especially when first starting a business. Impacting sales projections, planning for expenses, and cash flow, this skill makes it easier for you to see how your business will do not only today, but tomorrow, next week, and next month. Financial forecasts make it possible for you to determine whether you’ll have sufficient funding to keep your business operating in the future, or if additional funding may be needed.
Mastering Financial Forecasting: Predicting and Planning for Small Business Success
The Importance of Financial Forecasting in Strategic Planning
A financial forecast will project sales, expenses, and cash flow into the future of your business, allowing you to determine areas where financing may be required to prevent your business from shutting down or suffering other financial difficulties. But beyond seeing into the short-term future, financial forecasting also plays other roles in your business, specifically in your strategic planning process.
Having a strategic plan for your business gives your budget some place intentional to put every dollar and gives you strong direction on which way to go as you face a range of issues in your company. Though you’ll still want to have a buffer set aside for unexpected emergencies, having a strategic plan that includes expected growth, capital equipment replacement, annual expenses, and similar revenue and expenses in place makes it easier to make decisions that are in line with your overall strategic plan.
Think of it this way: if a business didn’t plan for capital equipment replacement or for a slow season, the business might be caught without enough funding to successfully complete the financial cycle. With a plan in place, the owner, management, and leadership of the business can make decisions that are in line with the plan, preventing wasted time, money, effort, and materials.
How to Create Financial Forecasting Models and Projections
Though expenses, revenue, and cash flow all look at different aspects of your business’s overall health, all three follow the same basic rules when undertaking your financial forecasting. The biggest difference is which factors you’ll be considering.
- Define your financial forecasting purpose. What do you want to learn? Are you estimating sales or determining if your budget will work? These purposes will help you decide which measurements to use in the process.
- Pull your past financial data and statements. The past got you to where you are today and will help you determine where you’ll go in the future. You’ll want to know about revenue, liabilities, equity, expenses, losses, investments, income, per-share earnings, and fixed costs.
- Choose a timeframe. How long do you want to go into the future? For a business that has a regular income, you can create financial forecasting based on a few weeks’ data, but for irregular or seasonal income, go for several years. Most companies use a single fiscal year. If you’re doing long-term planning, pull long-term data and trends.
- Decide what financial forecasting method to use. Quantitative forecasting uses existing historical data for identifying trends and patterns but may not take into account industry changes. For those changes, a qualitative forecasting method that includes expert opinions and sentiment about the business and industry is more accurate.
- Document the process and review calculations. Much like weather forecasts, financial forecasting isn’t 100% accurate and will change more the further you get from the point of analysis. Document your process for future use and revision and check its accuracy after strong internal or external changes. Automation can make this process easier.
- Analyze the data. By regularly checking the data created regularly in your business against your forecast, you can determine how accurate your financial forecasting will be. You can also determine when your goals and plans should be accordingly adjusted.
- Repeat. Based on your timeframe in #3, repeat your financial forecasting on a regular basis to ensure that you’re still on top of the figures and in control of your spending and income.
By understanding how these documents are created, you’ll have a much better idea of how to leverage them to your company’s advantage in the future, including when you’re preparing an annual budget, finding problem areas, setting intelligent business goals, attracting investors, and reducing your risk. You’ll also be able to undertake innovative discussions about your company’s financial health with financial institutions, creditors, and other organizations you work with.
Why You Should Regularly Review and Adjust Financial Forecasting
However, it’s not enough to simply finish these financial forecasting models. You’ll also want to take time on a regular basis to review and adjust as needed to optimize your results. As an example, if you have higher or lower sales or expenses than was forecast, you have the option of slowing down the progress of your strategic plan or speeding it up. The strategic plan will still come into play, but it will have its timeline adjusted when financial forecasting is reviewed and adjusted.
Though financial forecasting can seem like a very complex process, it’s actually fairly straightforward once you understand the basic processes that are involved. Why not take a little time when things are quiet and work one out using the steps above? Once you’ve figured out how to accomplish this task, your business will be in much better hands and will be facing a much stronger future.
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Disclaimer: Avisar Chartered Professional Accountant’s blog deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein. Although every reasonable effort has been made to ensure the accuracy of the information contained in this post, no individual or organization involved in either the preparation or distribution of this post accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.