A Guide to Financial Forecasting
One of the main reasons new businesses fail is because of poor financial forecasting. Research from ACCA revealed that 82% of businesses failed due to poor cash flow management skills. A good financial forecast can significantly reduce the risk involved with starting up a new business. Financial forecasting will help you on the way to setting and achieving goals to get your venture where you want it to be.
Unfortunately, many guides to this tricky subject are full to the brim with jargon, making it very difficult to simply find the information you need. To ease this process, we have put together this short guide to help you start your business on a solid financial footing. A well thought out financial forecast can get you on the right foot.
So, What exactly is a financial forecast?
In simple terms, financial forecasting is a financial plan or budget that estimates your projected income and expenses. The best place to start is to create a cash flow forecast by calculating upcoming income and expenses when they are due. This way, you will know how much money you need to make every month in order to keep moving.
The financial forecast element is your best guess of what will happen to your finances over a certain period of time. These estimates will allow you to form targets for where you expect your figures to be after three, six, nine months and beyond. Financial forecasting will allow you to develop your profit and loss statements, balance sheets and the all-important cash flow forecast.
Obviously, if you are starting your first business and have no prior trading history, this task can be very difficult. It is only natural for your financial forecasts to be inaccurate. Don’t worry, as frequent amendments to your forecasts based upon your latest figures will ensure that your accuracy will improve considerably over time.
Why is it important to prepare a financial forecast?
A recent study cited that 82% of businesses fail due to poor cash flow, this is a pretty compelling enough reason but consider this as well. It is also something that an investor will ask very early on to determine the validity of your business concept. Investors and lenders will be most keen to learn when you believe your business will become profitable. A financial forecast is perfect for helping to prove this.
After the period of your forecast has passed, you will be able to compare your actual revenue against your projected revenue. Draw conclusions from any discrepancies between the two that may occur. This will mean your next forecast will be more effective as you can learn from any mistakes made previously.
What components are needed to create a financial forecast?
Initially, your forecast will be based upon industry and market research, as you do not have any trading history. As your success will be judged against any predictions made, it is therefore important you make targets achievable. Conversely, setting unreasonably low targets will more than likely mean that you hit them. This will give an unfair reflection of your success levels.
Your financial forecast should also go hand-in-hand with your business plan. With allowances made for the capacity of any production equipment. For example, if in month nine you plan to purchase a larger piece of equipment which will allow you to produce more products, both the cost of this and the added income it will bring should be reflected in your financial forecast.
How often should I create a financial forecast?
Simply put, there are no rules. This is completely dependent upon the circumstances of your business and how far along your business plan you are. If you are reading this blog you are presumably just starting out. So you will need to develop an annual financial forecast alongside your business plan to prove your concept is viable. As mentioned previously – to help gain any necessary financial backing.
During the early months of your business and during periods of rapid growth or difficulties, weekly or monthly forecasts are necessary. These allow you to keep a close eye on your figures. Meaning you can effectively adapt to your changing situation. Alongside this, you should regularly compare your financial forecast against the actual figures and, if needed, adjust your forecast to reflect these changes.
Let’s face it: It is important to keep financial matters in mind from start to finish (and as you grow your business). With growth may come the need for more finance. Look back at a recent article we published on Raising Finance for your Small Business (with Infographic), or even taking your SME to an International Market.
A final note: Why is it important to prepare a financial forecast?
It is a crucial (if not the most crucial) assessment of how viable a business idea is. Save yourself the pain and heartache of a business not making enough money by carefully planning costs, estimating income and assessing whether it will make enough money to be worth pursuing. Whilst a financial plan for investors is key. In reality, it is often further down the line before a small business will consider outside finance (if ever at all).
No dream too big if you dream big but think strategically!
Published Thursday, January 16, 2014