What are financial forecasts?
Financial forecast is a projection of future financial outcomes and operating results of the company. The results are based on previous financial data. Financial forecasts concern incomes, expenses, capital expenditures and sources of funding. They are an integral part of the professional financial management system of the company.
After the realisation of the financial forecast, it becomes an essential element in subsequent periods. It is a key intangible asset in rational decision-making, especially when it comes to matters concerning managing financial flows.
Something that businesses badly need
Since the very beginning of the company’s activity, there is a need for financial forecasts. The company has to know what are the possible financial benefits, what is the payback period of the invested capital and how high is demand for additional financing. Thanks to financial forecasts, business owners become much more aware of what to expect.
There are two main financial forecasting methods – quantitative forecasting (which uses historical data to identify trends) and qualitative forecasting (focused on analysing experts’ opinions).
How to create a financial forecast?
If we want to create a financial forecast, we need to know that it has to be based on expenses we can control (because we are the ones who dispense cash). For example, we mean capital expenditure that we have to take, providing the right distribution in time. We generally need cash flow statement and all past financial statements which provide aggregate data.
Another example is an estimate of the fixed costs of running a business, including costs of sales, costs of marketing and office expenses. We also include costs of services such as consulting, IT, accounting and legal services.
Do market research, market analysis…
The next issue is a revenue possible to obtain and variable costs we need to incur in a two-year time horizon. In this case, we must think of all the variables which affect generated financial results of the business.
There are a few things which can be really helpful in preparing a valuable financial forecast. Business owners might need market research, market analysis, experience in creating financial forecasts, cooperation with employees and ability to gather information on the development direction of the business from the people who have a real impact on that business.
There is a tool enabling creating a financial forecast – we call it a financial model. It’s an analytical tool in Excel which supports the management of corporate finances due to its management reporting and providing up-to-date rolling financial forecasts. Financial models enable business valuation, assessment of financial feasibility, business goals and KPIs setting.
Summing up, financial model functions are not only creating financial forecasts but also obtaining financing, evaluating the profitability of investments, valuing a company, defining KPIs and monitoring them, and also investor and management reporting. Thanks to the modelling, we can calculate the financial impact on the company’s balance sheet, income statement etc.
Financial forecasting process
You can do financial forecasting in a few steps. The first thing you should do as a business owner is to designate the people who would be worth engaging in the process of financial and cash flow forecasting. You should define areas of responsibility in your company. Subsequently, you ought to appoint a leader for each area.
1. Appoint people who are worth engaging in the forecasting process
You shouldn’t choose people who work in accounting for being leaders because accountants usually pay attention to historical data of the company, but they don’t necessarily know the company’s goals and the business strategy. Engaging only the company management is not a good idea either. The management team members would focus only on financial forecasting, and the other business areas would probably be irrelevant to them.
So who should be appointed for creating financial forecasts? Certainly, the people who are responsible for key areas of business such as marketing, sales, finances, logistics, HR, business development and administration.
2. Identify variables which affect financial performance and refine the business model
Each business has its own specifics, and that’s why it’s important to independently assess factors affecting incurred costs and generated revenues of the company. Each time, we should start with the sales funnel analysis.
The sales funnel may consist of the number of sales representatives, the number of leads obtained by the sales representatives, conversion time (counted in months), conversion from leads to customers, the number of new clients obtained by the sales representatives, the total number of users, net revenue etc.
We have to remember about identifying factors affecting variable costs. These may include server maintenance costs, the number of users who are served by one person from the customer service department, customer service costs, technical service costs and administrative costs.
3. Create financial model in Excel
If you would like to improve updating financial forecasts, you should develop a financial model for your business. Updating the financial model shouldn’t take more than 2 hours. Furthermore, make sure that each person concentrates on the chosen variables, for which they have sufficient knowledge.
4. Develop your business growth strategy (with market analysis)
The next necessary step is to set goals – strategic objectives (big and long-term goals, such as entering a new market), operational objectives (how to achieve the strategic goals, e.g., building a team responsible for entering a new market) and tactical objectives (concrete activities which bring the company near to achieving the operational objectives – improving the recruitment process or initiating new people into the business).
Management team members should make every effort to plan all the necessary material investments; to prepare revenue forecast and operating expenses forecast; to indicate the most appropriate source of financing; and to allocate excess cash in equity investments.
Forecasting of future outcomes
When it comes to forecasting future outcomes, business owners should ask themselves a few questions. Which social channels would be the best for attracting customers? What kind of actions connected with cross-selling and up-selling should be taken? Which group of customers is the most profitable? Which market seems to be the most promising?
People responsible for their businesses should know answers to the following questions. Which channel is the most cost-effective? How much to increase the marketing budget? How to optimise the work of customer service? Which tasks can be optimised? Which costs can be optimised?
5. Prepare initial financial forecast
All the strategic assumptions should be submitted to the people chosen in the first step of the process. If we have all the needed analysis and tools, we can try financial planning and preparing financial forecasts, starting with capital expenditure. This group of expenses can be forecasted with high accuracy because we, as business owners, keep expenses under control. It also means buying machines, office equipment, means of transport etc.
We also have to consider costs – the ones concerning management and administration, such as salary costs, business travel, rentals, and maintenance of the office. We have to remember about costs concerning marketing and sales, such as costs of marketing agencies, budget for promotion and advertising and so on. Furthermore, we cannot forget about production costs (semi-finished products, manufactured products) and project implementation costs.
There is nothing as hard to forecast as revenue. However, we should try by identifying variable. There are a few types of revenues – production revenue, project revenue, sales revenue and additional activity revenue.
Financing and capital investment
Sources of financing? They usually appear in small and medium-sized enterprises. Those include grants, loans and advances, operating lease etc. It’s worth determining the sources and the level of financing in the last stage of forecasting. When it comes to capital investment, take into account the investment value, the time of investment (year, month), rate of return and investment period.
6. Analysis of financial forecast
The last step – financial analysis – is the quintessence of financial forecasting. At this point, the business owner can assess what will be the impact of planned strategic, operating and tactical activities on the company’s forecasted financial performance. Thanks to that, it will become possible to make better decisions that will turn into more beneficial financial results.
Why is financial forecasting a key to your business’ success?
Without financial forecasting, business owners won’t be able to make good business decisions, which are rooted in data and facts. They should be aiming to develop a habit of creating monthly financial forecasts – thanks to that, they will know how to plan their next steps in relation to budgeting, operations and funding.
Every so often they need professional help and there’s nothing wrong with that – quite the opposite! That’s what business consulting services are for. If you’re a business owner, you don’t have to act alone and blindly. There are professionals with many years of experience in the industry. They are willing to help you create financial forecasts and provide advice and practical support. It would be a pity not to take advantage of it!