If you were considering driving out to the beach for a week to soak up the sun and have fun with your family, you’d check the weather forecast… right? You’d want to make sure that it’s going to be warm with clear skies and the perfect breeze.
As a small business owner relying on the income from your endeavor to care for your family and create a good future, wouldn’t you also want to “check the forecast?” Financial forecasting is essential to your business – yet too many entrepreneurs don’t know what it is or how to do it.
You are different. You want to create the best possible business and life for yourself. Learn how to financial forecast and you’ll be looking at clear skies for the foreseeable future.
For more tips on how to better manage your business finances, check out this blog.
Need help with managing your business expenses?
Contact Larry L. Bertsch, CPA & Associates, LLP today!
What is financial forecasting and why should I do it?
If financial forecasting is a new concept to you, you are not alone. Not all entrepreneurs have a degree in business and many learn how to manage business finances on the job. Just like you learned tracking your business expenses and expense reporting along the way, now it’s time to incorporate financial predictions into your repertoire.
Financial forecasting is the act of predicting what direction your business is going in and what you may encounter along the way. This prediction is based on how your company has performed in the past, what’s going on in the market, and a variety of other factors. With this information, you can create a budget and decide how you will spend money over the next few years. To be clear, creating a budget and financial forecasting are NOT the same thing. Learn more about how they differ.
There are many reasons why financial forecasting is important for small businesses. The history of your business has information that can help you avoid pitfalls, create new offerings, and inform important budgeting and business decisions. In addition, if you plan to apply for a loan, or request government assistance (like during a global pandemic), you’ll be asked to provide this type of information.
You can learn more about the top 3 benefits of financial forecasting for your business here.
How to create a financial forecast for your business
Producing a financial forecast for your business boils down to three steps.
First, you must gather your business’s financial records so you can see how the business has performed in the past. Next, you’ll decide what type of forecasting style you’d like to use. Finally, you’ll prepare your pro forma statements
Gather Your Business’s Financial Records
Financial forecasting is an educated prediction of your business’s future performance. Keyword… educated. Without looking at detailed past performances, you’re engaging in wishful thinking and wild guessing.
Reach out to your bookkeeper and let them know what you plan to do. They can generate the financial statements you need for this process. If you haven’t yet hired a bookkeeper, look to your bookkeeping software for these answers. If you don’t have these records available to you (perhaps because you didn’t know you need to do them), you’ll need to create them before you can move forward.
With up-to-date financial records in-hand, it’s time to move to step two of the financial forecasting process.
Decide on Your Forecast Style
There are two different styles of financial forecasting. To create your educated prediction, you can use
- Historical forecasting
- Research-based forecasting
- A combination of the two
Let’s take a closer look at how these forecast styles work.
Historical Forecasting vs. Research-Based Forecasting
Historical forecasting uses your financial history to predict the future. To do this, you’ll need to look at several years’ worth of:
- Annual Income Statements
- Cash Flow Statements
- Balance Sheets
By plotting your growth over the past few years, you can predict what your business growth will look like moving forward. This is fairly quick and easy; however, it doesn’t take anything besides your business into account. Market trends, competitors, or a global pandemic could throw a wrench into your prediction.
Research-based forecasting takes the entire industry into consideration. You’ll look at performance over the past 10 years, examine industry trends and your competitors, and measure your own progress against that of your competition.
While it’s very thorough and may give you a more accurate picture of the future, this type of forecasting can be time-consuming and expensive as you may need to hire outside assistance. Research-based forecasting is great when your company is new (without a lengthy financial history) or when you’re looking to bring on investors.
Most small businesses will use a combination of these two types to meet their goals.
Create Your Pro Forma Statements
Now it’s time to create the statements that will allow you to “see” the future. You’ll need to make a:
- Pro forma Income Statement
- Pro forma Cash Flow Statement
- Pro forma Balance Sheet
How to Create a Pro Forma Income Statement
A Pro forma Income Statement estimates your desired future growth and then allows you to create a production schedule to reach that goal. For example, your interior design business made $50,000 in sales this year. Next year, you’d like to make $75,000, a $25,000 increase in sales.
What do you need to do over the next year to meet that goal? Will you take on more clients yourself? Will you hire an assistant who can help you serve more clients at a time? Or, will you create a digital offering that doesn’t require you to be an active participant in some designs? Create a plan.
Once this is done, you’ll need to look at all your expenses. How much does it cost you to purchase the items necessary for your business and your clients? Will this increase or decrease as you handle more sales?
This information becomes your Pro forma Income Statement.
How to Create a Pro Forma Cash Flow Statement
Similar to a regular Cash Flow Statement, a pro forma will let you know how much cash you have available at any time and whether or not you’ll be able to pay your bills. To create this, take the info from your Income Statement and put it into a Cash Flow template to see where your money is going.
How to Create a Pro Forma Balance Sheet
Pro Forma Balance Sheets are created using previous balance sheets, your income statement, and your cash flow statement. This information will tell you how much your organization is worth now, may be worth in the future, and whether you need to move money to have it available for bills.
Compare Your Pro-Forma Statements to your Actual Financials
Once you’ve created Pro-Forma Statements and predicted your financial future, you’ll need to compare it to what actually happens. At the end of the month, quarter, or year, do side-by-side comparisons with these numbers and see how accurate your predictions were. This will help you make a better prediction and thus a better financial plan, for the future.
Understanding Your Projections
There are generally three potential outcomes to this process. Your projections may be:
- Up – You will expect growth over the next year
- Down – You will expect to spend more money and make less over the next year
- Flat – You will expect to see approximately the same numbers as you had over the past year
Remember, these are just projections. Changes throughout the year could create a different outcome.
Experience Financial Forecasting Made Simple with Larry L. Bertsch, CPA & Associates
Now that you understand how important financial forecasting is to the future of your business, it’s time to get started. If your books are not in order, you don’t have the data necessary to carry out your forecasting, or you’d just like help you with your forecasting, Larry L. Bertsch, CPA & Associates is ready to help. We can take away the headache of organizing your business financials. Contact us today and let us help ensure that your business forecasts are bright and raining money!