There are several financial tools that all business owners can use to help grow their business. We’ve previously discussed how to create a cash flow assessment, a business continuity plan, and a business scorecard. In this post, we’re going to look at how to create a financial forecast for your small business that will help guide you through the next year and beyond.
What is Financial Forecasting?
Financial forecasting involves looking at the revenue, operating expenses, and budgeting of a business against the backdrop of market trends to predict a future scenario. These forecasts can be short-term or long-term, but if they are to be effective, they must be adaptable, no matter the time period covered. The financial forecast is not something business owners create and then store in a binder and only to bring it out again for year-end reflections. Financial forecasts are documents that should be used and reviewed at a minimum of on a quarterly basis and continuously adapted to account for new information.
The Art of the Forecast: Adaptation
Financial forecasting has similarities to weather forecasting. With the weather, a meteorologist uses a range of data, including wind patterns, recorded temperatures, air pressure systems, and geography, to model weather patterns. As a result, they make a forecast of what the upcoming weather will be. And as anyone who has ever attempted to make weekend plans based on a weather forecast knows, the predictions can rapidly change. What was predicted ten days in advance will often shift when it’s five days in advance and can shift even more two days or even 24 hours before.
While financial projections should not fluctuate as much as weather forecasting, the key similarities are the ability to be flexible and make updates based on new events and data. A meteorologist cannot predict where a wildfire might ignite and therefore affect surrounding area temperatures, just as business owners cannot always predict when a supply shortage will occur, or a global pandemic will happen. What both types of forecasts can do is take in the new scenario and adjust the predictions based on the new information.
The 6 Steps to Creating a Financial Forecast
Gather Your Past Financial Statements
Before you begin forecasting your business financials, you must first understand your current business performance. You can start by pulling the three pro forma statements: your income statements, balance sheets, and cash flow statements for the previous year. When you review these historical reports, you should be looking for trends in your sales, investments, losses, expenses, and profits.
Analyze Financial Needs
Based on your results from previous years, you can start to create a picture of your financial needs. The more detailed your review is, the more precise your sales forecast will be. The goal is to have a clear picture of the following areas of your business:
- Revenue streams
- Operational costs
- Cash flow
With a clear overview of the financial performance of your business in recent years, you’ll be able to move on to the external factors that might impact your plans in the coming months, quarters, and years.
Calculate Gross Margin
Using the data gathered from your past financial statements and the analysis of those statements, you can put together a projected income statement and calculate your gross margin based on those numbers. The gross margin is usually calculated as a percentage of revenues and is the result of your net income, less the costs of goods sold. The more details you include in your projections, such as economies of scale and costs of input, the higher the degree of accuracy your margin projection will be.
Create a Budget
Now that you have a sense of the financial future of your business, you can use that to inform your business budget. A robust budget will account for unexpected expenses as well as have a plan for savings. Your financial projections can help you adjust those columns in your budget to make the most of your money.
Research Market Trends
Even with the best business plans and projections, external factors can have an impact on a company’s profitability. Examples of these include breakthroughs in technology, stock market fluctuations, natural disasters, or political events. The number of external factors that can affect any business is numerous. Market research can help you predict and adapt to some of those impacts.
Monitor and Adjust
Once you have a forecast in place and a budget established, it’s important to monitor the progress of your business. It would help if you regularly were asking questions about whether there have been any world events that could affect your projections. Paying attention to the news in your industry can help you catch potential problems early on. Watching out for any event that might impact your supply chain, including the demand for your service or product, or the access to your product or service, can help you react faster.
Lessons Learned During COVID-19
The COVID-19 pandemic has been a demanding exercise in forecasting ability. Some examples of recent events that probably would have impacted your sales forecast in the past two years would have included:
- Government-imposed restrictions
- Customer access due to health risks
- Supply chain disruptions due to the pandemic, port strikes, weather, etc.
- Labour shortages
- Increase in remote working
- Increased home delivery options
Creating an effective financial forecast is about more than coming up with accurate numbers at the start; It’s about monitoring your market and making fast adaptations when needed. Think of your forecast like a compass. Sometimes you’ll be blown off course and need to readjust your settings to get to where you want to go.
Financial Forecasting for Small Businesses in Edmonton
If you’re a small business in the Edmonton area who is struggling to create a financial forecast,
the Chartered Professional Accountants at Schwan & Associates CPA are here to help. We’ll work closely with you to understand the nature of your business challenges and create a financial forecast that is realistic, robust, and custom-to your company. We’ll also give advice on how to best monitor your forecast to make rapid adjustments when needed. Contact us today to learn more.