Financial forecasting is an essential tool in any business owner’s toolbox. Successful companies use these forecasts to estimate costs, anticipate profits, and prepare for potential obstacles in their business’s future. Although forecasts are only projections, not facts, they provide valuable insights to help you make big financial decisions.
The Importance of Forecasting in Business
A financial forecast is a type of projection that takes a big-picture look at all the variables that might impact your business’s bottom line over a given period. These variables could include rent increases in your office building, inflation and other economic factors, the addition of new employees, or new product launches.
Financial forecasting helps you set goals and avoid roadblocks as your organization grows. These forecasts can cover the next quarter, fiscal year, or five to ten years of business operations. Looking at your projected profits and subtracting your projected expenses will give you a clear look at a potential future budget.
Often in business, things don’t go according to plan. To truly be prepared, it’s important to create not just one but at least three types of financial forecasts: one for a best-case scenario, one for a worst-case scenario, and one for a realistic, average scenario right in the middle.
How to Create a Financial Forecast
To create a financial scenario analysis for your business, you must first ask yourself questions about your finances. I discuss this in detail in my article “13 Steps to Become the Macgyver of Small Business Budgeting,” but here are a few examples of questions you might consider:
- What new products or services will we launch over the projected period?
- Do we anticipate any changes to our operating expenses?
- How might our prices change in the near and distant future?
- What new equipment might we need to buy now, and when will our company grow?
- What impact will inflation have on our costs and prices?
- What are our competitors doing, and how will that impact us?
- What should our optimal inventory levels be?
- Are there any governmental, tax, or legal changes to consider?
- What are our top 5 gross margin strategies, and how will they affect our plan?
- What staff additions or upgrades do we need to invest in?
An excellent financial scenario analysis will consider both internal and external factors.
Once you have your list, write down an assumption to answer each scenario. These assumptions will serve as guiding factors in your financial forecast. For example, you might assume you will launch one new product next year. You can use past data to estimate the impact on your business.
Next, plug your numbers into each assumption’s cash flow projection template. I’ve made this one available for free, or you can create your own with some Excel know-how. Use data from previous years to get a feel for what these estimates should be.
Your forecast results can paint a picture that will help you determine what success looks like for your business. The final forecast will allow you to make crucial data-informed decisions at every step. While financial forecasting is not an exact science, it’s still a valuable tool for any business owner to master.
Financial forecasting is just one tool for keeping your small business on track. For more information, please read my weekly articles on business management and leadership.
Coach Dave
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