Every business has goals. If you want your company to grow, a financial forecast will help to arrange the budget and plan purchases for it. For example, you will see if it is possible to upgrade equipment, update software, look for a more spacious office.
Another reason is if your business faces an unexpected lack of finances regularly or you are not confident in its financial position. A good financial forecast based on the most accurate information of your statements will help to solve problems or at least understand what to do to improve the financial state of your business.
Even though it sounds complicated, a financial forecast takes three basic steps. So, let’s break them down in this post.
What is financial forecasting?
A financial forecast predicts the state of your business in the future. It requires making certain statements, which are called pro forma statements. The major three of them are:
- An income statement shows how much money comes in and goes out of business.
- Pro forma balance sheets predict assets, liabilities, and equity. They are using data from other company’s reports or documents. The more precise data is used, the more accurate the financial forecast will be.
- A cash flow statement shows how a benefit will be produced using the cash.
Pro forma statements look like common ones but are more hypothetical and based on the what-if concept, not actual financial results. For example, what if my business gets a $25,000 loan in 2021?. The pro forma statements will show how the income, cash flow, and an account balance will look like for this particular case. For a successful result, all three statements need to be completed correctly.
The statements can cover different time frames depending on a business owner’s goal. For example, if it is a financial forecast for personal planning purposes, then its recommended creating pro forma statements that cover from six months to a year. If the goal is to provide such a report to a lender or investor, it’s better to cover from one to three years.
Some applications can make statements for you. The statements are important because predictions are using this data, so they should be as accurate as possible.
Why do small businesses need financial forecasting?
Financial forecasting will help a business owner in the following scenarios:
- To engage potential investors by showing how their money will be used and how the business will grow due to it.
- As a well-detailed plan for the future to consider the best and worst financial states of business.
- Foresee the changes like reaching a new tax bracket.
All that you have to do to make a reliable financial forecast may look like a big task. However, divided into smaller steps, it proves to be less complicated than it seems. And of course, there are professionals in this field, so if you’re about preparing a solid forecast for investors, we recommend turning to a specialist.
How to create financial forecast in three steps
Even if you are not going to do it yourself but rather delegate the task to a professional, I believe that for you, as a business owner, it would be helpful to know what it takes to create a forecast. Knowing where the details come from, you’ll better understand the final figures. So here are three basic steps to take in financial forecasting.
1. Ensure accurate financial statements
Financial statements are the basis for creating a forecast. And as far as they are made using your accounting data, it’s vital to ensure that it is up to date and accurate.
Usually, it’s a bookkeeper’s task to bring the data on all your transactions into the books. But also, various solutions can help to do it and ensure even more accuracy by automatically importing transaction data into accounting.
For example, Synder can take transactions (including those of past years, should you need) with all the details from the platform you use for payments and transfer them to your QuickBooks or Xero company. The app will create a sales receipt or invoice and expense for the payment processor fee for each sales transaction, as well as it will create transfers to your checking for easy reconciliation. In addition, Synder helps to manage accounts receivable.
Done with it, you can start planning the financial future.
The forecast can be historical or research-based.
The historical forecast includes the information of your pro forma statements for past years. Research-based forecasting means that you have to look at how the industry you work in has performed for past years. Everything counts, like technologies, trends, analysis of your competitors, etc.
Needless to say that the best strategy of this step is to find a balance between historical and research-based forecasting.
3. Create the pro forma statements
When you have enough information gathered for the forecast, it’s time to create the pro forma statements. You choose whether you need three of them for personal use. But if you want to present this information to a third party, it is recommended to include all the three.
Budgeting vs. Financial forecasting. What’s the difference?
Financial forecasting is often confused with budgeting. And to make it clear we will highlight the differences between these two terms for your better understanding.
Budgeting is a baseline to compare the expectations and results of a company. It includes revenue and expenses estimates, expected cash flows, debt reduction, and actual results to the difference between two numbers. Budgeting may target things that cannot be achieved due to any circumstances or changing market conditions. If a company relies on the budgeting and makes decisions according to it, the budget should be reconsidered more than once a fiscal year.
The financial forecast, in turn, indicates if the company meets the budget goals and prospects for development in the future. It also helps managers to estimate the number of upcoming deals, moreover, it allows them to develop a business plan.
Can a business do well without financial forecasting?
Many people think that financial forecasting is more of a lottery that you cannot guess. But if you take reliable cash flow data of a business and complete all the steps in financial forecasting, this will help not to miss the red flags and find growth opportunities. To make it short, no one will blame you for not doing financial forecasting regularly. However, when it comes to making big business growth decisions, they are better to be data-driven. So here is when financial forecasting will be of solid help.