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financial forecasting
5 min read

How to do financial forecasting

One of the biggest challenges you face when running your own small business is making decisions that are not only right for now, but also the future. Things change over time and sometimes they change quickly and/or significantly, which is something you must always be mindful of. It’s impossible, of course, to know with complete certainty what the future will bring. But you at least need to be able to look ahead and predict what is most likely to happen, so that you can make decisions that are more likely to ensure the survival and success of your small business. Financial forecasting offers you that possibility.    

What is financial forecasting?

When based on reliable information and realistic assumptions, financial forecasts look into the future to provide you with a prediction of your business finances that you can have a reasonable amount of trust in. Financial forecasts usually cover a period of between one and three years for most small businesses.

To retain their value to your business, you need to update your financial forecasts every year. But because you are able to update your estimates with actual figures, you can improve your forecasts and perhaps make your predictions even more reliable going forward. 

The three main financial forecasts

  • financial forecasting
    Sales forecast

    This predicts the amount of income you expect to make from sales each month over the course of your sales forecast. This might be higher in certain months and lower in others.

  • financial forecasting
    Cash flow forecast

    This predicts sums of cash likely to enter and leave your business over the course of your cash flow forecast. Making a cash flow forecast can enable you to identify and take steps to avoid times when you risk running out of cash, which can kill your business if you take no action.

  • financial forecasting
    Profit and loss (P&L) forecast

    This predicts how much profit or loss you expect to make, given your likely sales and costs (ie fixed costs or overheads as well as your variable or direct costs).

Financial forecasting – the pros

Without financial forecasting, you really are running your business blindly. If based on reliable information and knowledge, financial forecasting is the best way to predict the future, stay out of trouble, and make your business more successful. Financial forecasting can enable you to:

  • set budgets
  • control your costs
  • manage your cash flow
  • avoid cash flow problems
  • make informed operational decisions
  • make informed business development decisions
  • protect your business from risks and take advantage of opportunities
  • identify your business funding or finance needs
  • better control your business finances
  • prove to funders and investors that your business is well managed.

Financial forecasting – the cons

So what are the cons? Well, importantly, your forecasted figures are just that – forecasts. Your actual trading figures can be better or worse to a greater or lesser extent (if they’re much worse your business could be in real trouble).

Sometimes things can happen that can totally throw out your forecasted figures, for example, you suddenly lose your main customer, or inflation ramps up your costs. Or you might suddenly win a big customer, which means your forecasted figures are too low, which isn’t such a bad problem, although you’ll have to update your forecasts.

If your forecasts are wildly out, it can give you a totally unrealistic perception of how things are likely to pan out for your business, which could give you a false impression of how well your business is performing if you’re using your forecasts as a benchmark.

Producing forecasts requires effort and commitment; you need to set aside enough time each month to update your forecasts. And if you lack knowledge or experience, forecasting can be difficult and time-consuming. However, the more you do it, the better you can get at financial forecasting, so it takes up less of your time and your forecasts become more reliable. 

How do I create financial forecasts if my business is established?

If your business has been trading for a number of years, financial forecasting can be easier, because you can base your forecasts on actual historic sales and cost figures. Gathering together such data from your P&L, cash flow and sales statements and forecasts when making new financial forecasts makes the task much easier.

However, your future sales and costs are likely to be different to a greater or lesser extent, with costs, in particular, having risen significantly for most UK small businesses in recent years. And you can’t afford to take anything for granted when it comes to your sales, that’s why you also need to use your market knowledge when doing financial forecasting. Your knowledge of your customers, competitors, and suppliers can really add accuracy and value to your new forecasts when your historical trading figures offer limited value.  

How do I create financial forecasts if my business is new?

Financial forecasting can be more challenging when you don’t have any trading history to draw upon. The solution, of course, is to carry out market research to find out information about your customers, competitors and suppliers, which will help you to predict your future business income and costs. Obviously, you must ensure that your research comes from reliable sources. You may also need to research external factors that could affect your forecasts, such as market trends and macro-economic influences.

In truth, even if your business has been trading for a number of years, carrying out market research is still worthwhile. And when producing financial forecasts, many business owners and managers create forecasts based on different scenarios – best-case, worst-case, and somewhere in the middle. Then you can plan for each so that you don’t get caught out.

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