Financial forecasts lay the groundwork for your business’ success. This plan dictates measurable quantitative goals for your business operations.
On top of that, positive forecasts that are reliable will result in a higher probability of acquiring loans from financial intermediaries and capital from investors. Although a forecast may seem like an opportunity to exaggerate your potential, it is important to accurately portray true projections.
Financial forecasts are based off of past business performance metrics. The numbers are pulled from incurred expenses in addition to generated revenue. Through extensive market analysis and potential product development, your team will be able to extrapolate data showing incremental change in demand over time. This overall process is very labor-intensive and takes collaboration from all levels within an organization. Business owners must evaluate every aspect of their financial statements in order to best determine future growth.
Slow and Steady
The first step in forecasting is to gather all of the relevant details. All historical information since the company’s inception needs to be collected.
With this information you can visualize trends within your net income, operating expenses and other key performance indicators that provide insight to the internal business structure. This process should be performed with caution, and each component should be analyzed individually. If you find that there has been stagnate revenue growth, then you have to translate this over to the projections. For example, if sales have experienced a 1% growth rate each month over the past 12 months, then this should be applied to the future monthly sales projections. By continuing this process, you will eventually have a financial timetable dating as far into the future as necessary.
This is where your financial forecasts cannot simply rely on historical information when making predictions. If a new product or service is going to be introduced in a couple of years, then appropriate changes need to be made based off of assumptions of the impact. The addition of another product or increased production of an existing one will also translate to increased expenses. Advertising costs will rise to increase product exposure, and other costs such as direct labor and materials will grow to satisfy the anticipated spike in demand. Due to the compounding nature of these expenses, managers have to take their time in figuring out how one additional process could affect the whole system. Expenses should be evaluated closely. Rent, utilities, property, plant and equipment are all categories that can face price surges when a company experiences growth. Although these typically constitute some of the largest expenses, they are also some of the easiest to estimate.
A contribution analysis, where managers determine how each business process contributes to success, can be performed to eliminate any unnecessary costs or pinpoint where any growth potential lies. This analysis also evaluates the market to identify if you are working with the most profitable market segment presently available. If it is revealed that a profit is not being made in a particular market, then it will be wise to either exit or readjust financial objectives and target markets. Financial assumptions go hand-in-hand with forecasts and have to be made at the onset of the process. These assumptions will effectively drive the forecast and serve as benchmarks for the company.
Put pen to paper
Upon the completion of your financial assumptions and analysis, you are finally ready to put the information down in a user-friendly manner for investors and company personnel. Excel spreadsheets are commonly used to visualize this information as it provides the ability to change assumptions and thus the forecast quickly and efficiently. Outside professionals such as accountants may be hired to support the business. Projections of a company’s financial statements can be set up in Excel in the exact way that they are situated in an annual report.
A detailed financial forecast allows a company to set more time-specific goals. You are able to track progress and adjust best practices if you are not meeting goals before it gets too late. Companies will be able to figure out which additional assets will support sales and their associated cost on the balance sheet. Although it might not be perfectly accurate, the financial forecast will provide great insight to a company and help build upon existing progress.