Whether you have just started your business or are in a phase of rapid growth, a financial forecast will help guide your daily decisions so you can accomplish your business goals.
A financial forecast is also a prerequisite for accessing capital or even selling your business.
Anytime an outside party; a lender, an investor or a buyer plans to inject money into your business, they will want to review your historical performance and your financial forecast.
A FORECAST IS NOT A BUDGET
While a budget and a forecast are similar, there are a couple of key differences.
A budget is more commonly used as a tactical tool by businesses to help manage cash flow and expenses from month-to-month. A budget typically looks no more than 12 months into the future and often takes a more granular approach than a forecast.
A financial forecast is more strategic in nature and tends to take on a longer-range view of three to five years. Where a budget may reflect your short-term plan, a forecast is the roadmap for your long-term vision.
HOW TO CREATE A FORECAST
The first step in any forecasting process is to first reflect on the past. Review your financial statements from the past one to three years and look at how the business has trended recently.
Once you’ve gotten a thorough understanding of the business up to this point, it’s time to predict where it’s headed next. This predictive process is part art and part science. It takes on the perspective of what you aspire the business to look like but must also be grounded in reality.
PREDICTING REVENUE
Begin with projecting your revenue into the future. As you plan for what you want and think your sales will look like going forward, make sure to continuously review past trends. While a forecast should be aspirational, it’s important it’s realistic, particularly when you plan to share it outside of the company.
For example, if sales have grown 10% per year, you’ll need to really question a projection of 40% year-over-year sales growth going forward.
That’s not to say such a growth rate is impossible, rather it just needs research that supports it. It could be that the whole industry is rapidly growing. Maybe you’re launching a new product or service that will increase your sales. Perhaps you’ve increased your marketing spend or are planning to sign a new large customer.
Whatever the case may be, make sure you thoughtfully project and document your assumptions.
PROJECTING EXPENSES
Once you’ve arrived at your projected revenue, the next step is to forecast the expenses you’ll incur to meet your revenue projections.
For example, if you’re projecting an increase in revenue you may need to increase staffing, purchase more office supplies or upgrade your IT infrastructure to service your new customer base.
While you may be able to forecast revenue in one bucket, you’ll want to separately project each major expense category.
Remember to include inflation in your projections. It’s rare that even fixed costs don’t increase over time even in the absence of increased sales.
DON’T FORGET TO RE-FORECAST
You’ve sat down and thoughtfully mapped out the next three to five years. Congratulations! You’ve built yourself a guide for the future!
Don’t file away your forecast and forget to review it. Much like you might review your budget monthly, you too should review your forecast and adjust the plan.
Sit down periodically with your historical financial statements and your forecast and evaluate if you’re still on track. If not, review each line item to determine what needs to be adjusted.
If you’ve overspent or grown more slowly than you’d planned, consider adjustments you can make to your operations to get back on track. Revise your forecast to re-project future months and years with the benefit of current information. Remember, a forecast shouldn’t be static.
FINANCIAL FORECASTING FOR EXIT PLANNING
If you’re planning for an eventual exit from your business, a financial forecast is a critical component of that plan. Not only will it help you grow your company today and stay on track with your strategic plan, but it will also be invaluable when you go to sell or transition your business.
Any buyer of a business is making a calculated investment. Before presenting an LOI or offer, buyers need to evaluate the risk and future potential of their investment.
A well thought-out and continuously updated forecast will help them see the path to future growth and demonstrate to them that the current owner has a good handle on how to continue to scale.
STARTING YOUR FORECAST
Don’t know where to begin, or feel like your forecast just isn’t working the way you expected?
In addition to exit planning and business growth advisory work, we also offer project-based engagements.
We’re well versed in developing budgets, forecasts and strategic plans. If you could use a little help getting started or laying the initial groundwork for a forecast, contact us.