Financial forecasting is essential for any business type and business size. You need it to receive funding from banks or investors and is necessary for you to understand how to ensure your business will be successful. Predicting the future of any business is difficult but a financial forecast will be helpful for understanding what the success of your business can look like financially.
What is Financial Forecasting?
A financial forecast consists of projected financial statements, also known as pro forma financial statements, to help forecast the profits and balance sheet accounts. Pro forma statements are just like the financial statements you use each month to see how your business is performing. The only difference is that you prepare pro forma statements future months and years.
In a financial plan there are three statements that are needed which are an income statement, cash flow statement, and the pro forma balance sheet. These need to be completed in the correct order. Once these three statements are finished, you should be able to show how your business will change over time.
Financial forecasting is important to understand how your business should grow over time. Business owners should look into creating a financial plan that will forecast the business between 6 months to a year. It is important to revisit and update the financial forecast each quarter or when a major event happens. Although financial forecasting is not the same as bookkeeping, you can look at your past accounting records to help guide you make your predictions for the future.
What is included in a Financial Forecast?
- Sales Forecast
- Project your sales and set it up on a monthly/quarterly basis. Include unit sales, unit costs, and cost of sales.
- Use your past patterns to get a sense of the future of your business. Are there changes in sales season to season?
- Calculate your cost of goods sold. The formula for COGS is your beginning inventory plus your purchases and subtract your ending inventory.
- Expense Budget
- Include both fixed and variable costs.
- Cash flow statement
- This is based on your balance sheet and sales forecasts.
- Projections of your income
- Use the numbers in your sales forecast, cash flow, and expenses.
- Assets and Liabilities
- Assets and liabilities that are not included in the profit and loss statement.
- Break-Even Analysis
- where your expenses match your service or sales volume.
After you have created your income statement, cash flow statement, and pro forma balance sheet, compare them, and see if they sync up with each other. You can try doing a quick ratio which is your cash, cash equivalents, securities, and accounts receivable. A ratio that is 1:1 is good anything higher than 1 means your company has a lot of liquidity, less than one means low cash flow.
The Difference between Financial Forecasting and Budgeting
You might be wondering what the difference between financial forecasting and budgeting is. A budget you create is where you plan to set some money aside for your costs and take into account your income and expenses. Your budget is based on the information from your financial forecast but is different than the actual financial forecast.
To simply put it, financial forecasting is a prediction and budgeting is a plan. Based on the past performance of your business you can see what direction your business is headed in the future when you make a financial forecast.
A budget is a plan that shows how you are going to spend money based on your forecast.
Types of Forecasts to Create
When making your financial forecast, consider not just making one but a couple and consider different scenarios that could happen in the future. Having different possible outcomes for your business will have you prepared no matter which case happens.
Consider creating a best-case scenario forecast, worst case scenario, and a normal scenario forecast. The more detailed your forecast is, the better you will be able to plan for the future of your business and know how to prepare for it. Having these three different financial forecasts available will impress lenders and investors as well because it shows you have thought of different outcomes.
When you have completed your financial forecasting you can use it to better handle the growth of your company. By having a financial plan you will have success in finding funding for helping your company grow because a bank will most likely require your financial plan when applying for a loan.