Forecasting is a valuable, sometimes overlooked, part of small business ownership. Business forecasting helps small business owners predict growth and identify where to tighten up expenses or work to expand sales.
What is Financial Forecasting?
According to Investopedia, forecasting is the use of historic data to determine the direction of future trends. If you’ve ever reviewed the previous month’s revenue to predict how much you’ll make the next month, then you’ve already started forecasting.
Forecasting can show how to allocate your budget or plan for anticipated expenses for an upcoming period of time.
Why is Financial Forecasting Important?
Forecasting can be great tool for many business functions including:
- Helps manage the company finances
- Helps estimate the future revenue (or loss)
- Helps in the decision-making process
- Forecasting expenses
- Inventory reordering
- New product performance
- Evaluating recent marketing efforts
How Forecasting Can Help Manage Your Budget
Cash budgeting is a process of predicting cash inflows and allocating cash outflows for a specific time period. Cash budgeting relies heavily on accurate cash flow forecasts.
Up-to-date forecasts help you know when you can estimate cash will come in and go out, expected sales and expected profit. One of the main reasons small businesses fail is because they run out of money to spend on their costs. Forecasting correctly can help prevent this.
Select Forecasting Method
There are a number of different methods by which a business forecast can be made. All the methods fall into one of two overarching approaches: qualitative and quantitative. An easy-to-understand article outlining these approaches can be found on Investopedia here.
Three basic models of forecasting to consider are outlined here. A short summary of each is below.
- Extrapolation - Extrapolation uses historical revenue data to predict future behavior by projecting the trend forward. The time-series method is a popular quantitative forecasting technique, in which data is gathered over a period of time to identify trends.
- Regression/Econometrics - Regression analysis is a statistical procedure based on the relationship between independent variables (factors that have predictive power for the revenue or expenditure source) and a dependent variable (expenditure source being predicted).
- Hybrid Forecasting - Hybrid forecasting combines knowledge-based forecasting, rather than data and statistics, as the basis for the forecast. Hybrid forecasting methods are very common in practice and can deliver accurate results.
To get started, gather the elements you’ll need to build your forecast. Start by reviewing your company balance sheet that reports assets and liabilities at a specific point in time. Put together a list of last year's expenses along with the expected cost of proposed projects and promotions for the next year.
Once you have those numbers, follow these guidelines from the bizfluent blog:
What Can Impact Your Forecast
When you’re forecasting, it’s important to consider factors that can impact your numbers. These include:
- State of the Economy and Industry – In a growing economy, consumers will be more likely to buy your products or services. Keep in mind that the local economy may have more of an effect than the national economy. For example, if you offer home improvement services where the housing market is strong, you’ll be in better shape than in a city with falling prices. Look at what financial experts predict locally and nationally when you’re preparing your forecast.
- Your Competition - Keep an eye on the competition. New businesses in your industry could decrease sales and require a beefed up marketing strategy. Current competitors who increase inventory or advertising could also impact your business negatively.
- Technology - Failure to adapt can cripple your business. Are your computer systems up to date? Do you have the most advanced payment and fulfillment processes on your website? Being vulnerable to computer hackers and viruses can put your customer’s information at risk. If this isn’t in your wheelhouse, consider hiring a contractor to do a technology audit and suggest how you can get up to speed and protect your online assets.
- Seasonality - Does your business have seasonal cycles? For example, some businesses move more inventory and have more income during the holiday season. A landscaping business might have a great summer but a not-so-great winter. Looking at your income statement can help you identify the cycles.
Keep in mind that forecasting is not an exact science. If you keep your forecasts up to date, you’ll be more likely to be prepared if something unexpected happens.
You don’t have to go it alone during the forecasting process. Check out this list from Capterra to find software that can help: Top Sales Forecasting Software Products.
There are also a number of books that address this subject in-depth. Sales and Market Forecasting for Entrepreneurs from business expert Tim Berry is a comprehensive, easy-to-understand guide.