How to create a financial forecast
Posted: Mon 19th Aug 2024
As a small business owner, financial forecasting might seem complicated, especially if you're not well versed in business finance. But creating a financial forecast is crucial for understanding your business's future.
By predicting revenue, expenses and cash flow, you'll make better business decisions, manage cash more effectively and increase your chances of growth and profitability.
This blog breaks down financial forecasting, helping you create accurate predictions that can inform your financial planning. It'll also be important when you need to put together the financial section of your business plan – especially if you're seeking funding from banks or investors.
What is a financial forecast?
A financial forecast estimates your business's future revenue, expenses and profit over a specific period – usually a year or quarter. For a small business, it serves as a financial roadmap, outlining where your money will come from, where it'll go and what your expected profits (or losses) will be.
How forecasting helps you
Creating a financial forecast lets you:
budget more effectively
monitor profitability
understand cash flow needs
Forecasting gives you a proactive look at your business's financial future, so you can plan for growth or reduce risk. Having a reliable financial forecast can be the difference between sustainable growth and financial struggles.
What's in a small business financial forecast?
Revenue projections: Estimating your income
Revenue projection is about estimating how much income your business will generate. Start by listing your products or services and forecasting how many sales you expect over the forecast period.
If you're launching a new product, this might require market research or benchmarking against competitors in your industry.
Example: If you run a small bakery, estimate the number of cakes, pastries and other items you expect to sell each month. Multiply this by your prices to get a monthly revenue estimate.
Expense forecasting: Anticipating your costs
Expenses are all the costs associated with running your business. To create an accurate forecast, list your operating expenses, including:
rent or mortgage payments
utilities
salaries or wages
inventory costs
marketing and advertising expenses
Separating fixed costs (like rent) from variable costs (such as materials) will help you understand which expenses might change as your business grows.
Cash flow forecast: Making sure you have enough to operate
A cash flow forecast tracks your cash inflows and outflows. Unlike revenue and expense forecasts, a cash flow forecast helps ensure you'll have enough funds available to cover your expenses when they come due.
This is essential for managing working capital – making sure you have enough cash on hand to pay for day-to-day operations.
VIDEO: A guide to cash flow forecasting
Adele Kilbane and Sean Hackemann share their insights on how to get to grips with cash flow forecasting. Learn about managing your short-term cash flow and preparing your business for the future:
How to create a financial forecast step-by-step
Step 1: Set revenue goals and estimate income
Begin by setting realistic revenue goals based on past performance or industry standards. If you're a new business, market research or competitor analysis can help establish initial projections. Break down revenue by month or quarter and include any seasonal trends relevant to your business.
Example: A florist might expect higher sales in spring for weddings and Valentine's Day, while a seasonal dip might occur in winter. Adjusting for these variations makes sure your forecast reflects your business's reality.
Step 2: List and calculate business expenses
Identify all the costs associated with running your business. For most small businesses, these costs fall into two categories:
Fixed costs: These remain constant regardless of sales, like rent, insurance and staff salaries.
Variable costs: These fluctuate with sales, such as the cost of raw materials or marketing efforts.
Once you've listed your costs, calculate your total monthly and annual expenses. A good tip is to track both expected and actual expenses each month to adjust your forecast as needed.
Step 3: Work out net profit and cash flow
To calculate net profit, subtract your expenses from your revenue. This will give you an idea of your business's profitability. Remember that net profit and cash flow aren't the same – cash flow reflects the actual cash on hand after all expenses are paid.
A cash flow forecast can help you avoid liquidity issues. Track when money is expected to come in (sales) versus when payments are due (rent, salaries, bills) to make sure your business can meet its obligations without falling short.
Step 4: Adjust for seasonality and growth trends
Seasonality and growth trends can have a significant impact on your financial forecast. If you run a seasonal business – like holiday retail, for example – plan for fluctuating sales. If your business is expanding, account for increased revenue and expenses related to growth.
Example: A landscaping business might anticipate peak activity in summer and slower periods in winter. Preparing for these trends helps with cash flow management during quieter months.
Tips for accurate financial forecasting
Use historical data if available
Historical data is one of the best indicators of future performance. If your business has been operating for a while, use sales, expenses and cash flow records to make informed estimates.
Look for year-over-year trends to gauge any patterns in your business, whether seasonal or related to customer behaviour.
Research your industry and competitors
Market research is particularly helpful if you're a new business without much historical data to draw on. In this case, review industry reports, consult competitors or study businesses with similar models to understand average revenue and expenses in your sector.
Example: If you own a new gym, researching other gyms in the area might reveal trends in membership rates and seasonal fluctuations.
Update your forecast regularly
A financial forecast is a living document. Regularly update it as your business grows, market conditions change or you gain new insights. Monthly or quarterly updates will keep it accurate and relevant, helping you make decisions based on current data.
Common financial forecasting mistakes to avoid
Overestimating revenue
It's tempting to be optimistic, but overestimating revenue can lead to financial problems if your actual income falls short.
Stick to conservative estimates, especially when starting out. Overestimating revenue might leave you unprepared to handle costs if sales don't meet expectations.
Ignoring seasonal fluctuations
Not paying attention to seasonality is a common mistake, especially for businesses with distinct busy and slow seasons. Be aware of the seasonal patterns in your industry, and adjust your forecast to account for these periods.
Underestimating expenses
Expenses often end up higher than expected, especially for new businesses. Avoid underestimating costs by reviewing every expense line and budgeting extra for unexpected costs. This is particularly important for variable expenses, which can increase as your business grows.
Key takeaways
Financial forecasting might seem daunting at first, but it's an essential tool for you as a small business owner. By understanding revenue projections, tracking expenses and managing cash flow, you'll gain valuable insights into your business's future.
Start small – use basic estimates if that's all you have – and build from there. Regularly update your forecast as you gain more data, allowing your forecast to grow alongside your business.
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