Financial Forecasting for the Health of Your Small Business

Financial forecasting is yet another essential small business skill that helps with financial planning.

Imagine if you had a crystal ball...

You could predict business trends, interest rates, market changes... You could make risk-free decisions, assuring the most productive and profitable use of all resources. You'd know what's coming so you'd know how to prepare.

But without a crystal ball, or at least a plan, you have to rely on past results - and it's often too late to make a change if you're already off course.

It's critical to set your sights on your personal and business goals, and map out a plan, so you have the right resources available when they're needed. Your small business survival depends on how well you can predict the future. Financial forecasting is a way to simulate your own crystal ball.

This "crystal ball" can help answer questions such as...

• What financial position will the business be in at the end of this fiscal year?
• What resources will I need to take it there?
• What financial commitments will I have to make along the way?

Combined with your experience and industry realities, the "what if's" of financial forecasting force you to think through growth opportunities, assess their feasibility, and plan the resources you'll need. And they help you clarify and quantify your anticipated financial needs so you can control expenditures before they happen. They also provide a benchmark so you can compare your plans with actual results.

Your Success Road Map

Picture your financial forecast as a road map of a 12-month trip. If you're well prepared, you can confidently forge ahead, without stopping too often for directions.

You may make twists and turns, and even get lost once or twice, but your sense for the general direction you need to head in will keep you on track.

What do you want to do next year? Increase sales gradually, within your comfort zone, so your business stays a manageable size? Or grow explosively to the point where you can sell it to a larger organization?

Do you want to be the hands-on decision-maker? Or do you want to hand the company over to a management team so you can get on with another start-up?

It's vital the you decide where you want to be in terms of finances, operations, sales and people over the next 12 months, so you can plan strategically how to get from here to there.

Your company can be the vehicle that delivers dreams for you and your family, so the exercise should start with your personal success needs.

Where do you see yourself?

Focus on your personal financial position and how you want it to change, then prepare a few strategies to get yourself there. If everything goes your way, what will your business look like?

Write down your personal goals for your business and your family. One of the biggest surprises small business starters experience, is the amount of time they have to devote to their venture. Not only is this about being energetic and healthy, it's about having some balance in your personal life.

A Cash Flow Forecast will help you know how you're doing, and whether you'll have the right amount of resources available to you at the right time.

If you're already in business, you can analyze your own track record and compare it with industry indicators. But if you're just starting out, you're charting new territory with no history to draw on. A small business mentoring group, or business development office may be able to provide standards you can relate to.

Say you make doggie treats. Your industry association can help you gauge typical costs and revenues, so you can compare them to your track record. If you're introducing a new concept, doggie drinks, for example, you can still rely on the established doggie treat industry for some indications of what to expect.

Operating Forecast

In the absence of a crystal ball, base your financial forecasts on your goals, the marketing research you've done, and what's happening in your industry, and keep a record of the assumptions you used.

Since you can't be sure what will happen tomorrow, develop a few financial forecasts based on different market strategies: best mark-up, lower mark-up and discount.

Of course, in your first year it's especially important to bring in enough revenues to cover your expenses, or at least to plan the finances to help you through this period. Financial forecasting helps clarify your options.

Fixed expenses are relatively easy to predict. Things like telephone, rent, insurance, light and power don't change with sales volume, so start your forecast by listing fixed expenses.

Now think about the costs associated with what you sell, like material, process and labor, and document them under Cost of Goods Sold,

As your business grows, you may need help. Your people plan should include who, when and why. Don't forget to allow for holidays, sick time, a reasonable hourly wage expense, and overtime at peak periods, Industry norms can guide you.

Plan your promotional activities and estimate their costs. How much money do your competitors invest in promotion, related to their revenues? If you're shooting for a higher market share than they have, you should probably invest more than they do - and set aside extra for contingencies.

Assess the Effect of Competition

Your appearance on the scene may stimulate response from your market, but it can also be the spark that ignites your competition. You need to be able to hang in for the long haul, so be prepared to fight for your share.

A Capital Plan

Physical assets like equipment, vehicles and furniture often incur financing and interest expenses. So your financial forecasting must include a Capital Plan of anticipated purchase and disposal of assets.

First, decide what assets you'll need to grow your dream machine. Then schedule the money to support your plan, month by month. If you can't see how a planned purchase will deliver new profit, do you really need it? Where practical, make do.

Pro Forma Balance Sheet

Drawing on your financial forecasting, you can now check your year-end score with a Pro Forma Balance Sheet.

If everything works according to plan, what will you own? What will you owe? How much money did you say you'd bring in? How much inventory will you still have on hand? These are current assets.

Then list your fixed assets, their opening balance, and the depreciation expense you're planning for the period. Don't forget the acquisitions and disposals proposed in your Capital Plan.

Balance these against the money you'll owe: bank overdrafts, loan payments, and set-asides for taxes. And for course, Shareholder's or Owner's' Equity and Retained Earnings - the one nearest your heart - the money belonging to YOU!

Know Your Break Even Threshold

Break-even is the point where sales cover costs and expenses.

How much do you have to sell before you show a profit? What if you offer X discount? Or outsource your manufacturing?

Once you understand the ins and outs of your dollars, you can juggle the "what if's" of various possibilities.

If you were to sell your break-even amount to one customer, your business would be profitable from sale two. But if prices drop or expenses increase, how much more must you sell? And if you increase production capacity to handle these extra sales, you crease your costs - how much then?

Here's a formula you can use to calculate your break-even point:

You can also use this formula to evaluate a major expenditure, or see how many sales you need to increase your profit. Just add the objective to Fixed Costs, and repeat the formula.

Conclusion

In some ways, financial forecasting is like shooting an arrow at a distant target on the side of a barn. You won't hit the bull's eye very often, but you won't miss the barn either.

And don't forget - consult your accountant or financial advisor as you implement your plans.

Additional information on financial forecasting and the other important aspects of business finance is available in the Business Buffet 5-in-1 video program: Financial Forecast, How to Read Financial Statements, Financial Analysis, Cash Flow Forecast and Bookkeeping. Check out Business Buffet here

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