Make Empowered Business Decisions with a Financial Forecast
your business needs a financial forecast
What is a financial forecast? Forecasts can take many forms, but basically, a forecast is a plan of what your finances will look like over a period of time in the future. It could be a forecast of your finances for the upcoming year, upcoming three years, or maybe just the upcoming quarter.
A financial forecast helps business owners map out assumptions and expectations for the future while also taking into consideration historical data. It helps assess risks that could arise as well as opportunities that they could take advantage of. It also helps business owners understand their path to profitability (or increased profitability) and growth.
One of the most valuable attributes of a forecast, in our opinion, is that it can assist in answering some of the difficult questions that arise for business owners.
For example:
Can I afford to hire a new employee?
How is my pricing?
Is my pricing high enough to cover my costs and make a profit I am happy with?
How much is it costing me to offer my service?
Even with the ever-changing landscape of a small business, it is important to have a framework where you can plug in the numbers associated with potential events or assumptions and think through how they will impact your finances.
Another thing to consider is if you are interested in getting a loan or funding for your business, creating a financial forecast is essential. Lenders and investors will almost always want to see a forecast. They want to understand your company’s growth potential as well as any hiccups your business may run into along the way. They also want to know that the business owner has thought through potential future outcomes and has developed a plan of action for dealing with those outcomes.
WHY do BUSINESS OWNERS often put off creating a FINANCIAL FORECAST?
There are two major hesitations we hear from business owners regarding the preparation of a financial forecast. We often hear business owners express that they don’t think financial forecasts are a worthwhile exercise because their business will most likely change a lot over the next year or two. What is the point in mapping out a financial plan when you might have different services or products down the line, or you might change the way your business operates or is structured?
Even though this might be the case, it is helpful to have a framework to start from. A financial forecast is a living document. It can change with your business. You can update it with historical data as it comes in or make changes depending on decisions you make. At least you have a starting place. I liken it to having an overall plan for your vacation. You have a hotel booked, a flight, maybe a few tours scheduled, but you have room to change your plans or take a short side trip at the last minute. There is structure, and you know the general costs, but there is flexibility to do what you want as well.
The other hesitation is that business owners feel like they don’t have the knowledge to create a forecast. How do I know what my sales will be like in a year? I can’t predict how many clients I will get over the next few months. Or maybe they feel like they don’t know what expenses will pop up or how to estimate those expenses? We will talk through some tips for this below. It can also be a good idea to bring on a partner, if your business is far enough along, who can assist when some of these items get a bit complex.
WHERE DO I START?
When we do forecasting bootcamps with our clients, we always start with a questionnaire. The questionnaire is essentially a data dump of what you think will happen with your business over a future period of time. We usually find that business owners have most of the answers to our questions looming around in their heads, and they don’t even realize it. Putting it down on paper in a usable structure is huge. Whether you are DIYing your forecast or are planning to bring on a partner, start to think through some of the questions below.
Income
Will your sales continue at their current rate, or will something happen that will either increase or decrease those sales. Will you do any marketing to drive sales? Has there been consistent growth so far that you can use to estimate future sales? Will you be offering new products or services that could increase your revenue? Are there any seasonal periods coming up that may increase sales? Have you identified any trends where sales increase or decrease that you can apply to future sales?
Expenses
What are the historical costs that you have incurred? Will they continue? Will you have any price increases for certain costs (for example, an increase in your insurance premiums or a subscription fee that will go up with the number of users)? Will there be any new expenses that you expect to incur?
For example, do you want to hire new employees or contractors? Will you need new supplies to complete a special client project? Are you planning to start offering benefits for your employees?
Are there any new plans that you are anticipating putting into action? What are projected costs that are associated with those plans? Might you need a lawyer to help initiate contracts or negotiate a new lease, for example?
Current and Long-term Assets
Current assets might include inventory. Are you planning to increase your inventory for the impending holiday season? Have you noticed more demand for a particular product and thus will need to carry more inventory for that product? What are the past trends for inventory over the last year? Do you anticipate that last year will be similar to this year? Or will you implement any changes related to your product lines or trends you have seen?
You might also think through your accounts receivable balance. This is the balance of open invoices that have not yet been collected but are due to you. Will you be putting actions in place to encourage payment of those invoices? This affects your cash flow, so it is important to think about it.
Regarding long-term assets, are there any big items you plan to purchase like large equipment, furniture, or computers? Do you plan to improve your leased storefront or office, thus seeing an increase in leasehold improvement expenditures? Take some time to think through the costs associated with these new purchases or projects.
Liabilities
Any plans to initiate a loan? It could be for a car or a business loan. If you do take on a loan, you will need to make payments for principal and interest, which should be included in your forecast. There are online tools and calculators that can help you estimate these payments, but enlisting a partner who can help with the calculations is never a bad idea.
Taxes are another area that often gets neglected. You may have payroll taxes, sales tax, income taxes, or local taxes that need to be paid. It is necessary that these get included in your forecast. Business owners often look at profit before some of these items are taken out, and it is important to understand the whole picture.
TAKE ACTION
The point of the above exercise is to get you to start thinking. What will happen in my business over the next year or so? You don’t have to have all the answers; you just need to put forth the time and energy to think through what you think might happen. Once you get some of the answers down, a forecast is just the exercise of assigning costs to these items as well as figuring out when they might occur.
I am a big proponent of getting a trusted partner to help you prepare a forecast. They can bring their expertise and experience to help not only sift through past data but also assign the appropriate costs to various events.
If you are wanting to go the DIY route, this is still a very valuable exercise. Start to plug your assumptions into a basic spreadsheet. If you are using bookkeeping software, an excellent place to start is by running a Profit & Loss report by month for the past year (export it to Excel). This will show what your revenue, cost of goods sold or services, and expenses have been for that year. You can then start to plug in estimates for future months for each category, keeping in mind changes you think will happen and adding in accounts as needed (for example, wages if you are hiring a new employee). Always remember that this is just an organizational tool for helping you to make informed decisions.
Also, if you are using the Profit & Loss as a template, don’t forget to add in items that are typically not shown on the P&L, like asset purchases, inventory purchases, loan principal payments, and some tax payments. If you have an anticipated cash outflow or inflow for any reason, it needs to be factored in.
FINANCIAL FORECASTING TIPS SUMMARY
Creating a forecast can be a daunting task. Start with some of the questions that we outlined above. Get your plans for your business out of your head and onto paper. Sometimes even just the exercise of adding structure to your plans is highly valuable. Then, begin to assign costs and estimates of when these assumptions will occur. Plug them into a simple spreadsheet or enlist the help of a trained professional.
You will not find a large corporation out there without a forecast. Small businesses operate the same way, just on a smaller scale. We think this exercise will light the path for future growth and informed decision-making! As always, reach out if you need our support and check out our Forecasting Bootcamps!