Why Small Businesses Need Accurate Forecasting
What is forecasting, how can small business owners do it right, and why should they?
Key takeaways:
- Small business forecasting is making future predictions based on actionable business data
- 4 tips for forecasting:
- Understand qualitative vs. quantitative forecasting
- Start with expense forecasts
- Create multiple forecasts
- Master cash-flow forecasting
- Stay flexible
Small business owners just starting out can quickly become overwhelmed by all their responsibilities. Business modeling, cash flow analysis, operations, hiring staff, and much more need to be worked out so the organization can start turning a profit as fast as possible.
Financial forecasting may seem overwhelming and almost unnecessary with all these other moving parts to worry about. Some business owners think that an accurate estimate is nearly impossible, and they may have no idea where to start.
But forecasting is an integral part of growth and long-term success. Here’s some perspective on this concept, along with tips for doing it right.
What defines small business forecasting?
Forecasting uses available data to predict future outcomes. It requires an analysis of the past and present to understand what’s likely to happen. Forecasting isn’t just for large companies, however—it becomes critical to growing a small business, and entrepreneurs are wise to embrace the concept early.
Small business forecasting requires creating the right financial statements, such as income statements, a business budget, and a balance sheet. The budget works in close conjunction with forecasting: the forecast predicts what will happen, and the budget helps the business get there. The other documents show business owners the facts as they happen. Forecasting also requires knowledge about what’s going on in the market since any economic changes can significantly impact the bottom line.
Forecasting helps a business stay on track, informs key decisions, helps owners understand if the current conditions are sustainable, and allows them to tackle possible issues proactively. For example, a component of forecasting accounts for tax responsibilities, and doing that correctly means the organization isn’t surprised come April.
4 tips for small business forecasting
Let’s walk through some key considerations and tips to getting started with small business forecasting:
1. Understand qualitative vs. quantitative forecasting
Qualitative forecasting is likely where you’ll begin. This is the process of making predictions when you don’t have a lot of data on hand. For example, you may not yet know what kind of expenses you’re dealing with or how the business model will fare. Qualitative assessment requires a bit more intuition and an overall market evaluation.
In contrast, a quantitative forecast uses data that you gain over time while running the business. It’s important to understand these formats, as you will undoubtedly utilize both approaches.
2. Start with expense forecasts
Many business owners mistakenly start with revenue forecasts. Instead, focus on expenses, which are much easier to grasp when you’re just starting out. List out fixed costs, such as rent, vendor bills, salaries, and marketing costs, along with variable costs, including the cost of goods sold and contract labor expenses. Keep in mind that advertising and legal expenses are often much higher than expected, so build a conservative buffer for those categories.
3. Create multiple forecasts
It’s helpful to create different forecasts: at least one for a best-case scenario and one for the worst-case possibility. You don’t want to be overly optimistic or overly pessimistic, so generating multiple projections allows you to see what the middle may look like.
Include both aggressive and conservative elements, and you’ll have a better idea of how to reach your goals and whether you’ll be able to hold up even if the worst should happen.
4. Master cash-flow forecasting
Healthy cash flow is critical to a successful business. And creating cash flow forecasts can keep you pointed in the right direction very early.
How much cash is going out versus in each month? Start tracking this data immediately to get a head start on cash flow forecasting. While things will probably change—whether unexpected expenses arise, clients are lost, or there is another economic downturn—conducting cash flow analyses and forecasting as you go helps plan for tighter months. And you can proactively cut costs where needed.
5. Stay flexible
Be prepared to make ongoing changes to your financial documents. Forecasts help you plan, but you need to be willing to take on whatever comes. Some months may be more than ideal, where others are a struggle. Think about how you can cut the biggest expenses or investments should it be necessary. Get creative with how you attract new customers.
Just remember that the more prepared you are, the easier it is to pivot later. If the pandemic has taught us anything, it is always best to stay open-minded and flexible.
How Provident CPA & Business Advisors can help
No matter how long your business has been in operation, forecasting is an essential component of financial planning. Not only does it help you align data to goals, but it also helps you understand if your business will be successful long term.
If you have no idea where to start or just need some assistance, Provident CPA and Business Advisors is here to help. Our team of experts can assist you with growth and profit improvement strategies while ensuring you minimize taxes as a small business owner.
To learn more about our financial and business support services, contact Provident CPA and Business Advisors today.