What is financial forecasting?
Financial forecasting is the process of estimating the future financial performance of a business, with an emphasis on cash flow position. A forecast is a powerful tool that allows meaningful decisions to be made in real-time, creating a competitive advantage.
Why is financial forecasting important?
Forecasting will help you think critically about the drivers of your business and major cost control areas and it tells your stakeholders, including your lenders, where you are now and where you want to take the business.
The impacts of COVID-19 have demonstrated the critical nature of cash flow. Businesses that were able to quickly estimate their future cash position could pivot effectively, turning a difficult time into an opportunity.
In the current banking climate, lenders are now asking for a three-way forecast as part of the standard finance application process. Lenders are also more likely to extend credit to businesses with a robust cash flow forecast, as it gives them confidence that the business has a plan and will be able to deal with deviations from that plan.
Questions your forecast will answer
Useful questions that can be answered with a robust forecast and have assisted our clients to maintain cashflow and in some cases even thrive throughout the pandemic include:
- Do you have adequate funds to cover the future?
- What does the future cash position look like if:
- revenue drops by x%?
- revenue increases by y%?
- costs such as stock purchases increase by z%?
- Will additional debt funding be required, and if so, what repayment terms will you be able to meet?
- Are staffing levels appropriate or do they need to increase or decrease?
What does a forecast look like?
A forecast should be “three-way” and include a forecast Profit and Loss Statement, Balance Sheet and Cash Flow Statement. It should show the timing of:
- income
- expenses
- capital expenditure
- debt repayments
- tax liabilities, and
- drawings/dividends.
Demonstrating the assumptions that support the estimates is key. The time period of a forecast depends on the business, however for most businesses monthly is appropriate, with a 12 to 24-month timeframe. This timeframe allows the forecast to be used to stress-test the business and identify for example what the future cash position will look like if revenue increases or decreases within three, six, or twelve months.
Be realistic and adaptable
Many SME business owners hope their business will achieve consistent double-digit or triple-digit growth, but these growth ambitions need to be realistic and achievable in relation to the forecast. Forecasting will enable business owners to grasp the reality of achieving their goals and reconsider short to medium to long term goals depending on current and historical data.
Your forecast probably won’t be perfect (and doesn’t need to be) but it will provide you with an indication of what the future is going to look like at any given time, so that actions can be taken to help your business reach its goals. Once it is setup with assumptions, you simply replace the previous month forecast figures with actual figures, tweak assumptions, and review the updated forecast.
How to begin?
Developing the forecast doesn’t need to be a difficult or onerous process and it can be improved upon over time. There are a range of tools available to help you build your forecast, at varying prices and levels of complexity.
Spreadsheets, for example Microsoft Excel, are an inexpensive option which are easy to share with management or business partners and allow for easy collaboration.
Simple forecasting programs such as Futrli, or Power BI, are a more advanced option but have the added benefit of connecting with most accounting software including MYOB, Xero and QBO. Like spreadsheets, these programs are inexpensive and relatively easy to use. And, data can be presented in a more engaging way for stakeholders.
More complex forecasting programs are also available, however these programs are generally more expensive than the options above and require a more advanced level of computing. For this reason, we tend to recommend them for larger businesses with more suppliers, possibly more lenders, and a wider set of financials to track.
In our experience, most small to medium sized businesses start their forecasting using a simple spreadsheet model before moving to a dedicated forecasting software as and when required. At William Buck, we can assist by designing your forecasting template for use on a spreadsheet or to be hosted on a program.
For more information on forecasting or assistance with your business strategy, please contact your local William Buck Business Advisor.
