Forecasting is basically the use of historic data to predict future events, and the wisest business owners make full use of the financial data at their disposal for everything from planning for upcoming expenses, to allocating budget funds.
Here are ten of the most-asked questions about forecasting, with answers that define why it’s something that every small business owner should take the time to understand.
- What is Financial Forecasting?
Financial forecasting involves extrapolating your company’s past revenues and expenses to get a sense of what its financial situation is likely to be at a specific point in the future. This estimated information makes it possible for the business owner to make operating decisions that are relevant, timely, and financially viable in getting their business to where they want it to be.
- How Does a Financial Forecast Differ From a Budget Forecast?
While a financial forecast estimates the revenue that your business can expect to earn in the future based on past efforts, a budget forecast is a reflection of the revenue that your business wants and plans to achieve for a future period of time. A budget forecast can serve as a blueprint for determining which areas of your business need to be trimmed back or ramped up in order to meet future financial goals.
- What is a Cash Flow Forecast?
A cash flow forecast allows you to estimate both the amounts and the timing of the cash that’s expected to flow in and out of your business over the course of a future period (usually the coming year), so that you can take any necessary steps to avoid becoming cash-strapped or short on liquid funds down the road.
- Why is Forecasting So Important to the Average Business?
Lack of financial planning is one of the main reasons given for small business failure. Not only does forecasting allow you to develop and maintain a competitive business strategy, it helps you to avoid cash shortfalls and is an important element in applying for and obtaining business loans and lines of credit.
- What Does My Small Business Bookkeeping Have To Do With Forecasting?
Organizing or outsourcing your bookkeeping in order to accurately and consistently track your business income and expenses, goes hand-in-hand with effective financial forecasting and budgeting. If you don’t know where your business sits financially at any given point in time, you’ll have no way of predicting or planning for its future performance.
- What Costs Does a Financial Forecast Consider?
Expenses are usually much easier to predict going forward than revenues simply because income can be affected by anything from evolving consumer trends, to economic downturns. The typical forecast will consider your company’s fixed costs and overhead (think rent, utilities, and wages), as well as variable costs like the cost of goods sold, customer service, and direct marketing.
- What is the Best Way to Estimate Revenues?
It can be helpful to consider two (or more) different sets of estimated revenues in your forecasting efforts. You can develop a conservative scenario, as well as a more aggressive one, in order to both define your financial expectations, and to inspire the goals that will help your business grow.
- How Can I Tell if My Forecast is Reasonable?
Using relevant financial ratios like gross margin (Revenue subtract COGS, divided by Revenue) and operating profit margin (Operating Income divided by Net Sales) to assess and compare the cost and sales projections in your forecast with current or past numbers, can help to determine how realistically viable they are.
To check out more financial ratios, go here.
- What Are Some of the Other Built-in Benefits of Forecasting?
Meaningful financial forecasting can help determine whether a new business idea is financially viable, will provide an effective benchmark for future performance, can help to keep your business on the right track in terms of its financial objectives, and will give you an effective model for projecting the various outcomes of different long-term strategies.
- Should I Seek Professional Forecasting Help?
Many companies are involved with outside partners or investors who want to see professionally prepared financial projections, rather than just best-guess estimates based on instinct and enthusiasm. Even if this is not the case for your small business, predicting future finances can be challenging, especially if your company doesn’t have much of an established financial history to draw from.
While many small business owners regularly perform their own financial forecasts, professional financial consultants are experienced in determining potential pain points within a business strategy, and are trained to recognize cash flow problems before they can happen.