How to put a financial forecast? Managing a business is never an exact science, and business owners constantly have to make tweaks to their operations in order to make it grow and succeed. The best business decisions are those that are based on facts and data. Therefore, if you are trying to predict the future performance of your business, you need to create a financial forecast.
A financial forecast is not just essential for large firms, but it is equally important for startups that are trying to raise funding so they can take their business to the next level. Now keep in mind that putting a financial forecast is not a one-time thing. If you are actively seeking investment, you might need to perform financial forecasting at least on an annual basis.
As a small business owner, familiarizing yourself with financial forecasting is an important step in the entrepreneurship process. With that said, a lot of new founders are still not sure how to put a financial forecast or how it works. If you are one of those entrepreneurs then keep reading this article, because we are going to explain all you need to know about financial forecasting and how to create one.
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What exactly is a financial forecast?
Financial forecasting is the process of making predictions about your company’s financial future to help make decisions about how a business needs to be run and to evaluate its potential. The process of making a financial forecast involves looking at how the business has done in the past, how it is doing now, setting goals, and any other relevant factors that may affect its financial performance in the future.
Financial forecasting looks at past and present financial data of a company to make calculated predictions about what a company’s financial situation will be like in the future. Financial forecasting lets management teams create future business strategies based on the financial information available. Including the business planning of a brand new venture.
At the same time, this forecast shows investors how profitable your business could be in the future, and what returns they can expect if they invest in your startup.
The current financial state of a business is very important, not just for its health but also to attract and retain investors. When there is a lot of competition for investments, the company has a better chance of getting money if the financial forecasts are done well. As we’ll talk about later, some components of a financial forecast can be different from company to company based on the type and purpose of the forecast.
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How does a financial forecast work?
You can make a financial forecast for your business as long as you have an Income Statement, Balance Sheet, and Cash Flow Statement and have done research on the market you are in.
You can make financial forecasts using all three of the above-mentioned financial statements or just one, depending on whether the forecast is for internal use or for investors.
For internal planning, a financial forecast may only need an income statement, while a projection for investors may use all three statements.
If you are just formulating your business idea and model, you will use credible market data, and industry benchmarks to supplement it.
Do keep in mind that you earning high profits is not mandatory for forecasting your financials. Check out this video I have created explaining how to present financials for a startup with no revenue. You’re sure to find it helpful.
Types of financial forecast
When you plan on putting together a financial forecast for your business for the very first time, you generally have two paths you could choose. One involves the use of cold hard data, and the other relies on market research to predict your company’s future performance.
Before you can choose either one and decide which forecasting method would work best for your business, you must know more about both of these forecasting types. So without further ado, here are the two key types of financial forecasts:
Quantitative financial forecasting (Using past financial data):
A quantitative forecast looks at past data to find trends and patterns and, of course, uses this data to create predictions about the company’s financial future. The fact that this method uses numbers means that predictions are less likely to be wrong than qualitative forecasts. Obviously, this method won’t work as well if you don’t have all the financial statements available.
The data used in quantitative forecasting can be measured and verified, making it a reliable method for forecasting. Most of the time, the information used for quantitative forecasting comes from your company’s Income Statement, Balance Sheet, and Cash Flow Statement. This information is then analyzed to see if the business is growing or not, and how fast this is happening.
The good thing about quantitative forecasting is that it doesn’t take a lot of time, money, or knowledge to do. The downside is that you only look at information about your own business and not broader market trends, such as what your competitors have been doing.
Quantitative forecasting alone is a good choice if you’re forecasting slower growth or if you just want to make a quick forecast for your own use, apply for a loan, and rework your internal budgeting, not for a presentation to potential investors.
Qualitative financial forecasting (Using market research):
Qualitative forecasting uses information that can’t be measured. This forecasting method is especially useful when a company is just getting started and doesn’t have much data available.
Financial statements can be used in qualitative forecasting if they are available, but it is not mandatory. The human mind is excellent at making connections between events and understanding the context. However, if you are forecasting for your own business, you can get a bit biased about growth and financial performance.
Because of this, you should use hard data when you have it, but qualitative predictions are your best bet when you don’t have enough historical data.
You could look at how your industry has changed in the last ten years, research new technologies and consumer trends, or try to figure out how your competitors are doing. You could look at how companies like yours have planned their own growth and make predictions based on their success.
Research-based forecasting is helpful because it gives you a detailed, nuanced picture of how your business could grow by taking into account many different factors. And this is the kind of forecast that investors and lenders want to see. Such as the predicted size of the market in the next ten years, and annual growth rates.
The problem is that forecasting that is based on research can be expensive. You might need to hire consultants and researchers from outside to do the heavy lifting. If you want to get investors or plan for fast, aggressive growth, research-based forecasting is a good choice. Though there are more affordable options. Such as hiring freelance and outsourced researchers and pitch deck creators.
How to put together a financial forecast for your business
Decide what the financial forecast is for
Ask yourself what you want to predict using a financial forecast before you actually start the forecasting process. Do you want to predict how many of your goods or services you’ll sell? Or maybe you want to know how the current budget of the company will affect its future. It’s important to know why you’re making a financial forecast so you can figure out what metrics and factors to use.
Get your records together
If you don’t look at how your business has grown in the past, you’re not really forecasting. You’re just making guesses.
You’ll need to look at your business’s financial statements from the past so you can see how it has changed over time and then try to predict how it will change in the future.
If you don’t have either and don’t have financial statements, you’ll need to take care of that before you can start forecasting. You need full bookkeeping to get a full history of transactions, which is what your financial statements are based on.
Choosing the forecasting method
As mentioned in the previous section, your forecast will be either qualitative or based on research or quantitative or based on data, depending on what resources you use.
Almost every financial forecast should be based on research and past financial data. The blend you choose will depend on your forecasting goals and how much past financial data you have available.
Once your books and financial statements are up to date, and you have the necessary market research, you’ll have everything you need to start forecasting.
Make future projections
First, make a goal for what you want to achieve, and then you can make projections about how you will grow into that during the time frame you’re looking at.
For each projection, it can be helpful to consider three different scenarios: the realistic, the most optimistic, and the most pessimistic. This will help you see how each one will affect your finances.
Your projections can also help you figure out how different business plans will affect your business in the future.
You can project what would be the outcome if you changed the price per product or how things may improve if you choose better technology to run your business.
Write down and keep track of results
Forecasts about money are never perfect, and they tend to change over time. So, it’s important to write down and keep track of the results of your forecast, especially after making big changes to the internal or external structure of your company. It’s also important to keep your predictions up to date, so they reflect what’s happening now.
Using software to automate tasks that are related to forecasting may also help. Or you can also hire staff to help you out with record keeping.
Analyze financial data
The best way to find out if your financial forecasts are right is by constantly analyzing the forecasts and comparing them with previous forecasts. The continuous analysis also helps you get ready for the next financial forecast and gives you important information about how the company is doing financially right now. Not to mention analyzing the results from current forecasts allows you to make decisions about your company’s future.
Repeat based on the time frame already set
As mentioned above, businesses should do financial forecasting on a regular basis so they can keep their projections up to date. It is best to stick to a schedule of forecasting that works best for you so you can create the next forecast once the current one becomes obsolete. It’s also smart to keep gathering, writing down, and analyzing the data to improve the accuracy of your financial forecasts.
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What are the benefits of putting a financial forecast?
Getting funding for your startup
Forecasting helps investors figure out how healthy a business’s finances are before giving it a loan, or taking an equity stake. To get the money or loans for your business to cover business needs, you need to make a good financial forecast.
To predict how much funding you need
With financial forecasting, you can get a clear picture of how much you will spend and make in the future. You can figure out how much money your business needs to cover those costs so that you don’t run out of money.
Making business plans
Forecasting will help you come up with a business plan that will help your company grow. It helps you spend your money and time wisely.
Better control of the flow of cash
One of the most important parts of running a successful business is managing money, more specifically, the cash flow of your company. Using financial forecasting will help you decide how to spend your money on different business expenses.
Scale financial performance
It lets you guess how much money your business will make in the future. It will help you set benchmarks for your performance so that you can improve it to meet the business goals.
Reduces financial risk
It helps you pinpoint specific financial risks that your business might be susceptible to. It helps you figure out where you spend the most money and cut back on areas that don’t bring in as much money. By knowing exactly what is going to make you the most money, you can avoid the risk of spending on projects that are likely to fail.
Now you should have a better understanding of the use of a financial forecast and how to create one. Based on the information provided in this article, there is no denying that a financial forecast is critical for a business and its financial future.
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