Financial forecasting is one of the most important things you need to plan and manage a small business.
This complete guide will cover everything you need to know about planning a forecast for your small business. So let’s get started.
What Is Financial Forecasting?
Financial forecasting estimates or predicts upcoming revenue, net profit, costs, and expenses.
You can do it by looking at financial data and predicting what might happen in the future. It can also estimate how changes in the economy might impact your business.
There are short-term and long-term financial forecasts.
- Short-term forecasting allows you to adjust your plans based on what you see happening shortly.
- Long-term forecasting can give you a better idea of where your business will be further down the line.
Financial Forecast Example
An expense forecast predicts what your business expenses will be doing in the future.
Do one by looking at past expenses. You can then estimate what you will need to spend on future business items. These include inventory, rent, and utilities.
On the other hand, an income forecast estimates how much income you will generate in the future.
Do one by analyzing your previous income over the last three months, six months, or year.
For example, if you gain $1,000 income a month on average, you can estimate it will be approximately the same amount in the upcoming months.
Importance of Financial Forecasting
Financial forecasting is essential for small business owners. It helps them understand all the potential profits and risks and predict future income and expenses.
By predicting this, you can make informed decisions about growing your business, like future financial planning, buying new equipment, and hiring additional staff.
You will also estimate how much revenue you will generate and how long it will take to liquidize your profit, so your small business can have a healthy cash flow.
Forecasting can also help avoid potential financial problems by identifying early red flags.
For example, your forecast shows income will decrease next month. Then, you can take steps to cut costs or increase sales. You can also postpone your plan to rent a new office or store until things get normal.
Advantages of Financial Forecasting for Small Businesses
There are several advantages of financial forecasting for small businesses, including:
You understand your past financial statements and behaviors and learn from them. You can also take notes of the good things you’ve done and repeat them if a similar situation arises.
This can be useful in setting goals and measuring success.
Another advantage is that it can help you make informed decisions about your business and track your progress and performance over time
In addition, financial forecasting can give you a glimpse into the future and anticipate changes in the market or your industry. In short, your future decisions will be data-driven.
Manage Cash Flow and Avoid Potential Financial Problems
By projecting your income and expenses, you can better know when money will come in and go out. This information can be helpful in:
- Make sure you have enough money to cover expenses
- Identifying problems
By identifying trends and predicting your business’s future performance, you can change your business to avoid cash flow trouble and contemplate some solutions.
For example, if your expenses are increasing but your income is not, you may need to adjust your budget or find ways to increase revenue.
Plan for Investments
Businesses that project future cash flow can know when they will have extra money to invest.
You can use this information to decide what to invest in and when to do so and help you track your progress toward financial goals.
There are different types of financial forecasting methods, depending on their approach.
Quantitative Financial Forecasting
This forecasting method gathers past financial statements and trends.
Most often, companies that have been in business for a while use this forecasting type. The accuracy of the quantitative kind depends on the quality and availability of past data.
This type of financial forecasting can be complex for businesses with a short history.
Qualitative Financial Forecasting
This forecasting method relies heavily on assumptions and expert opinions.
Start-ups or companies that haven’t been long in business use this method because they do not have enough past data to rely on.
Qualitative financial forecasting is less accurate than quantitative, but it can still give you a good idea of where your business is heading.
Financial Forecasting Models for Small Businesses
Here is a list of small business financial modeling for a forecast. So they’re easier to understand, we have divided them into bottom-up and top-down approaches.
Bottom-Up Forecasting Methods
As the names suggest, bottom-up forecasting starts with individual assumptions and aggregates them into a total forecast.
Individual Assumption Method
It involves making assumptions about what will happen in the future without using any past data or trends. If you are starting a new company or have been in business for some time, you should use this method.
It is the most basic bottom-up forecasting method.
Salesforce Composite Method
The sales force composite method uses the collective opinion of a company’s sales force to predict future sales.
Use this method if the sales force has many customer contacts, such as retail or BtoB sales.
Top-Down Forecasting Methods
Top-down forecasting starts with high-level assumptions and then disaggregates them into lower levels.
This analysis uses market trends to predict what will happen in the future. Use this method if you sell products or services.
Time Series Analysis
The time series analysis uses past data and trends to predict what will happen in the future. Use this method if there is a lot of business history.
The Delphi Method
This method is a qualitative approach that uses experts’ opinions to predict future income.
To do this, you will need to gather a group of experts and have them provide their predictions for future income. You can then average these predictions to get a final forecast.Learn to analyze your company's cash flow
Financial Forecasting Steps for Small Business
Below are the critical elements and financial forecasting best practices to start this process.
Think About Why You Need a Financial Forecast
- What sort of data are you looking for in the forecast?
- What data are you going to require?
- What are the crucial judgments you’ll have to make?
You will be able to figure out the aim of your forecast after answering these questions. And that will help you choose the suitable method and develop accurate predictions.
Common reasons to build a financial forecast are:
- To have clear reports of past performances
- Establish realistic business goals
- Mitigate business risks
Build, Review, and Analyze Your Financial Statements
This will give you the information and data you need to make your analysis or prediction.
Here are the three most important statements for small business financial forecasting:
The Balance Sheet
A balance sheet shows your company’s assets, liabilities, and equity at a specific time. It gives you an idea of what your company is worth financially.
The Income Statement
This sheet shows your company’s revenue and expenses over some time. It tells you how much money your company is making or losing.
The Cash Flow Statement
This one shows the inflows and outflows of cash for your company over a specific period.
It is essential because it tells you whether or not your company has enough cash to meet its financial obligations.
Understand What Forecasting Gross Markings and SG&A Expenses
Forecasting gross margin and SG&A expenses are the processes of anticipating future income and costs. There are many advantages to forecasting gross margin and SG&A expenses.
It can help businesses:
- Make informed decisions about product mix and pricing strategies.
- Allocate resources more efficiently
- Understand the relationships between different parts of the business
- Anticipate changes in the marketplace
Select a Financial Forecasting Method
Some things to consider when selecting a method include:
- What type of data do you have?
- How accurate do your predictions need to be?
- How much time are you going to allocate?
- How many resources or team members do you currently have?
Depending on your business, you may find that one method is more suitable than another.
For example, a time series analysis would be good if you have a lot of historical data to work with.
On the other hand, if you are starting a new business or don’t have much data to work with, then using assumption methods may be more appropriate.
Create a Document With All the Results, Statements, and Goals
The document with all your results, statements, and goals should contain the following:
- The name of your company and the products or services you offer
- Your mission statement
- Your goals and objectives
- A list of your target market segments
- Your sales forecast
- Your expense budget
- Your cash flow statement
- Your balance sheet
This will help you monitor your progress continuously and consistently. It will also ensure that you stay on track to achieve your company goals and objectives.
The document is also valuable for communicating with investors, lenders, and other interested parties.
Monitor Your Plan and Make Adjustments
Monitoring your plan and making adjustments will help ensure that your forecast is accurate and that your small business is on the right path toward your goals.
You must monitor sales volume, costs, prices, and gross margin. You should also keep an eye on your break-even point.
By tracking these metrics, you’ll be able to tell if your small business is meeting its goals.
If you find that your business isn’t performing as well as you’d like, don’t be afraid to change your forecast. Sometimes, all it takes is a little tweak here or there to get things back on track.
Some Great Software Financial Forecasting Tools for Small Business Owners
Many different financial forecast software is available on the market.
When choosing a program, it is always important to consider your needs, what features you require, how frequently you access it, and many other factors.
Below are the three software below that many small business owners use:
Excel is well-known spreadsheet software. While it may not look like it, you can use Excel for financial forecasting.
The tool also comes with several pre-installed features that make forecasting simple.
Forecast Pro is a software program designed specifically for financial forecasting. The system is easy-to-use and includes many features that aid in creating precise predictions.
You can also use a business intelligence tool like Crystal Reports for financial forecasting. Crystal Reports offers various features, and you can utilize them to create reports and visualizations.
Differences Between Financial Forecasting and Budgeting
As we’ve explained, financial forecasting refers to making predictions for the future based on trends.
Budgeting is creating a plan for how you will spend your money. It is typically made yearly and broken down into monthly or quarterly increments.
Having a budget forces you to consider what you will need to spend money on and how much to save. Budgeting can also help you avoid overspending and debt and track your company’s forecasting financial statements’ progress.
So, forecasting is more flexible than budgeting because it allows you to change your course of action based on what you see happening while a budget is set in stone.
Financial Forecasting is Essential for Small Businesses
Financial forecasting is always a valuable tool for small businesses.
Besides helping entrepreneurs like yourself make informed decisions about your business, it also helps determine how to price them and where to allocate resources.
Any business can benefit from financial forecasting with the right tools and information.
By understanding your expenses, revenue, and cash flow, you can better allocate your resources and plan for future growth.Learn how to make a complete financial plan for your business!
What is the purpose of financial forecasting?
It helps businesses decide what products or services to offer, how to price them, and where to allocate resources.
What is financial forecasting?
It is the process of estimating future income and expenses. This helps businesses make informed decisions about what products or services to offer, how to price them, and where to allocate resources.
What are the features of forecasting?
Some features of forecasting include:
What are the limitations of financial forecasting?
Some limitations of financial forecasting include:
What are the methods of financial forecasting?
There are two main types of financial forecasting methods: quantitative and qualitative.