Why Financial Forecasting Is Vital For Businesses

Financial forecasting is not just a business exercise, it can be the difference between a business failing or thriving. Despite this, a lot of small businesses simply don’t do this. Whilst it is understandable that they are extremely busy and may struggle to find the time, this article explains why financial forecasting is so important.

What is financial forecasting?

A financial forecast involves providing an estimate for the business’s future finances. There are several common types of financial forecasting that a business may want to undertake:

• Sales forecasting (predicting the amount of products or services you are expecting to sell within a certain timeframe)
• Cash flow forecasting- estimating the flow of cash in and out of the company over a set period of time
• Budget forecasting – this allows you to determine the ideal outcome of the budget and analyse any variances to the actual figures
• Income forecasting – analyses the company’s past revenue as well as the current rate of growth to estimate future income. This information is vital for cash flow, balance sheets and to present to potential investors.

Benefits of financial forecasting

Helps predict cashflow

We all know the saying “cash is king”, but it is especially true for businesses at the moment. Businesses with a strong cash balance mean they have more flexibility to seize opportunities but also more resilience if any unforeseen issues arise. For example, if they have customers that are delaying payment, or if sales have suddenly decreased.

When a cash flow forecast shows a lack of funds, this highlights the need to consider new investors, bank loans, grants etc. It also may suggest that the business needs to address which items they are able to cut back on. The benefit of the forecasting is that is should provide ample time to submit any applications and hopefully secure financing in plenty of time.

Cash flow can be a difficult thing for many small businesses to manage, due to how much it can vary. However, forecasts are a great way to predict these peaks and troughs and this means that they can be anticipated rather than them being an unpleasant surprise. It allows companies to know when it is safer to spend their money and when it is best to ensure cash is retained in the business. By knowing when cash flow will be an issue, a business can implement new pricing strategies, get invoices out quicker or look at other strategies. These changes will then be proactive not reactive.

Enables you to plan long-term

The joy of accurate forecasting is that it can help businesses create a long-term view of the company’s financials. This is great for creating a long-term strategy for the business and help solidify a plan for any growth initiatives.

Once you have your long-term vision, you can break it down into different periods. What exactly do you want the business to achieve by the end of each year? Once you have this in mind, you can look at the figures and see whether this is realistic or needs adjustment.

Useful for investors

Forecasting is also invaluable when it comes to raising funding for a company. Potential and existing investors will want a thorough understanding of where the business is now but also where it is heading. They want a return on their investment, and they need the business to highlight how this is going to happen and more importantly, when. Whilst forecasts are predictions and not set in stone, they are based on market trends, previous performance and more.

How to get started with financial forecasting

Forecasting needs to be as accurate as possible if business owners are going to rely on them to make important business decisions. Here is how to approach financial forecasting:

·         Ensure your forecast has purpose

Don’t create financial forecasts for the sake of it. Each forecast must have a purpose and determine from the start which metrics a business is going to be measuring and why. This will help provide focus.

·         Gather historical data

Where possible, use as much historical data as possible. This will help the results of the forecasting be more accurate. Revenue, losses, equity, liabilities, expenditures, salaries, fixed costs and more are all vital information.

·         Choose a timeframe

Establish early on how far in advance the forecasts will go. Often companies do forecasts for the following financial year; however this does not have to be the case. Just bear in mind that short term forecasts will inevitably be more accurate than long term forecasts.

·         Monitor results

Update forecasts regularly to see what the progress is. It is rare that the forecasts will be exact, so keep an eye on the results. Repeat the process once the initial forecast period is complete. Forecasts can be updated.

Risks of not undertaking financial planning

If businesses do not undertake sufficient financial planning, they will not be able to reap the rewards of doing so and can be at a disadvantage. Without effective forecasting businesses may encounter serious and unexpected issues that can ultimately lead to business failure.

Financial forecasting helps small businesses in many ways and should be something all businesses are doing. It can help identify new opportunities, create a long-term plan and stay ahead of the competition. Once these forecasts have been created, they can be used to successfully create a strategy and help with your business decisions.

If you need any more information about financial forecasts and how they can benefit your business in the long term, then get in touch with a member of the Wright Vigar team.