The Importance of Financial Forecasting

Your business needs a direction. Forging ahead without clearly defined goals has the potential for serious negative consequences. Goals and direction are perhaps most important when it comes to the life blood of a business – its money. This is why the importance of financial forecasting cannot be overemphasized, it is critical to helping a business grow. Yet, many business owners or managers may skip this step. It can feel too ambiguous - how do you predict 12 months into the future, when sometimes you don’t even know what’s happening in your business next week?

This may feel especially true for the smallest of businesses, who are just starting out or trying to rapidly react to the market. No matter your feelings, though, forecasting is a vital step toward improving financial planning for business. This article offers insight into what exactly financial forecasting is, the benefits and importance of forecasting, and some options to make forecasting easier.

What is Financial Forecasting?

According to BusinessDictionary.com, business forecasting is “a planning tool that helps management in its attempts to cope with the uncertainty of the future, relying mainly on data from the past and present and analysis of trends.”In essence, forecasting creates scientific estimates, based on hard data and critical analysis. Financial forecasting can offer predictions on a business’ future revenue and expenses. How much will you be making or spending in 3 months, 6 months, 12 months down the road?Often, forecasts follow an annual model, offering estimates 12 months into the future. A business may make a static forecast at the beginning of every calendar year, or implement a rolling forecast, which is further discussed below.To begin forecasting your finances, you should first start with projecting expenses - what will you need to be paying for in the future? Be specific - consider everything from bi-weekly salaries to annual insurance payments.From there, you can project your income. This can be tricky - how can you know how much you’ll be making in the future, especially if you are launching new products or services?

No matter what, forecasting involves a bit of guesswork. Just be sure that the guesswork has significant data and analysis to back it up. If you’re launching a new product, perhaps you can analyze how a similar product performed in its first year, then adapt it if your company has increased its status in the marketplace, or audience needs have significantly changed.

From there, you can combine your projected revenue and expenses to predict your future bottom line.

Deliver Budget vs. Actuals, Cash Flow Management, and Scenario Planning

How Does Forecasting Help?

Forecasting allows businesses to better plan their next steps. You won’t just be subsisting from day to day - you’ll be able to more accurately understand what you need to do to grow. Obviously, large enterprises may have whole teams of people responsible for financial forecasting. Steering a large ship requires expertise and forethought. Yet, even small businesses can benefit from the knowledge financial forecasting provides.

Forecasting allows businesses to create accurate budgets - what should you be spending? One survey found that 61% of small businesses did not create an official, formally documented budget. This can be a mistake. The survey explores case studies of what happens when businesses do not take advantage of financial forecasting and budgeting.

For example, when opening a behavioral health clinic, Rick McCartney and his business partners assumed that most of the clients from their private practices would transfer over to the new clinic. When they didn’t, the clinic struggled to remain solvent. “We each were personally subsidizing the business to make monthly obligations,” McCartney said.

McCartney and his partners did not accurately forecast the number of patients that would move to the new business, and were hurt when their expectations did not align with reality.

Now, McCartney’s clinic regularly budgets, allowing them to begin paying back the debt they incurred from their initial planning mishap.

Forecasting should help you be aware of if your business is going to grow – or if it’s going to fail.

It may be helpful to create several different forecasting models – including a best case scenario and a worst case scenario. While every business owner wants to be optimistic about their future, you will be able to recover quickly if you’ve already predicted what might happen in the worst case scenario.

Overall, financial forecasting better prepares your business for the ups and downs of the market – even if your predictions don’t turn out fully accurate.

How Can Businesses Better Forecast?

A rolling forecast model and forecasting software can both make your financial forecasting easier and more effective.

The Case for Rolling Forecasting

Consider your plans for life 5 years ago, 1 year ago, or even just a few months ago.

Have you needed to change those plans since first creating them? Perhaps you had a goal of buying a new car in a year - then you became sick and incurred medical costs, or didn’t get a planned raise. Most people know when it comes to planning personal goals that circumstances change - and goals may need to change with those circumstances.

The same applies to businesses. Many dynamically growing businesses may find that a static forecast does not allow them the flexibility they need to accurately forecast into the future.

If your business hasn’t been forecasting because you see it as too rigid, you can try a rolling financial forecast. This model follows an add/drop model – as each month passes, a new month is forecasted in the future. So, while a static forecast may only look from January 2018 to December 2018, a rolling forecast is added to throughout the year. With a rolling forecast, once January 2018 passes, the forecast model then shifts to look from February 2018 to January 2019.This allows your business to better adapt your future forecast based on your current situation.

Try Forecasting Software

There are a number of tools that exist that make financial forecasting easier for your business. After inputting data, financial forecasting software does most of the hard work for you, giving you projections that may feature less errors and more insight.

Some factors you should look into when picking a software solution include:

• Ease of use
• Loading speed
• Range of accessibility
• Drag and drop functionality
• Flexibility

In-depth online research and peer referrals are two good ways to find the best financial forecasting software for your needs.

Why is Forecasting Important?

The fact is that financial forecasting sets businesses up for success. Most stories of success began with a well-laid plan. Don’t count off the benefits of financial forecasting just because you’re too busy, it’s too complicated, or another excuse.