How to do 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. 

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.

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. 

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.  

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.