Small Business Financials: 8 Steps to Better Forecasting
VISA and SCORE have put together this eGuide to help you more accurately forecast your financial future.
The future is always brighter for those who can correctly predict it. With proper planning and research, a company’s chances for success increase exponentially. On the flip side, how much will it cost your business if you miss the warning signs ahead and create unreliable forecasts?
For small business owners, putting together an accurate forecast can be an arduous task. Proper planning is very important and thinking through many scenarios will only be advantageous as your business hopefully grows. Businesses should not just have a Plan B, but also Plans C, D, and E too as so many factors could impact your opportunities and ultimately your performance. Better forecasting starts with a proper definition of the term as well as creating an infrastructure to keep you focused and on track to meet your goals.
What is Forecasting?
Forecasting is the art and science of peering into the future to get some degree of predictability based on your prior operating history as well as the historical and current trends in your industry.
Forecasting helps manage the perils and risks of growing a business. Even "upside surprises" in a best case scenario situation can be hazardous. Some entrepreneurs will "lowball" their sales forecast only to find themselves scrambling to deliver products and services ultimately winding up with unhappy customers. If your pipeline is robust, then your forecast must include the ability to scale, including affordable access to growth capital.
How to Forecast
The best approach to forecasting is to not create a single plan, but rather one plan with three options. Your forecast should always include: the worst case scenario, the best case scenario and something in between. Be sure to identify and understand the dynamics of the variables which will influence your worst/expected/best case scenarios.
This discipline, often referred to as "sensitivity analysis," is defined as how projected performance varies as there are changes in the key assumptions in your forecast.
You then need to pay close attention to your plan with three options. At some point during the year, it will become obvious that you should abandon one of the options (hopefully it’s the worst case scenario). Having the options in front of you and reviewing them regularly means that your business won’t stray too far off course.
Keeping your finger on the pulse of what’s happening in the marketplace is an important element in forecasting. Your goal is to be proactive and not reactive. One point of note to startup companies: forecasting gets easier once you have a track record. The swings can be much wider with a startup company because your foundation of information is incomplete.
8 Steps to Better Forecasting
With proper forecasting systems in place, you can greatly reduce the fluctuation between budgets and actuals in business planning. Here are eight steps to make sure the plan you put together is a solid one.
Find the Hidden (variable) Costs
What percentage of your monthly expenses is tied to variable costs? Do you see regular fluctuations in the costs of materials and supplies? What about sales and marketing costs? For some small business owners, this is the single most important area of focus in trying to accurately forecast the future for their business.
Focus on Certain Economic Indicators
Which of the economic indicators are important to your business and/or industry? If you’re a retail business, consumer spending, unemployment, housing and lending indicators might be ones to watch particularly in your region versus the rest of the country.
Know Your Customers
Who are your customers and how do they use your product or service? What economic changes would make them buy more or less of your product?
Know Your Customer’s Customers
If you are a B2B company, then you must take the time to learn about your customer’s customers. The more you know about how your product or service is used, the better you can predict what changes in the marketplace will affect your business.
Know Your Competition
What is the state of competition in your market place? One of the biggest mistakes a small business makes is not accurately assessing the competition. If you have one client that represents at least 30% of your company’s total sales, imagine what it would do to your business if a competitor took them away from you.
Watch for Seasonal Changes
Historically we think of the four seasons and how the changes might affect our business. If we dig a little deeper, however, we can get a better understanding of when natural disasters most often occur to see how they may contribute to changes in your forecast. What’s your contingency plan should one of these disasters take place? If your business is based in the Midwest or that’s where your sales come from, then are you planning for the possibility of having your business disrupted by a tornado, flooding or a hurricane? On the West coast, watch for forest fires and on the East coast, winter storms and Nor’easters. With a proper plan in place, you can save your company from going out of business when disaster strikes.
Learn From the Past
With a business that is at least two-three years old, you have a track record of sales, expenses, cash flow and seasonal adjustments. By keeping proper business records and plans, you can greatly reduce the risk of putting together inaccurate forecasts. Not all past performances will reflect future business conditions, but it should help paint a clearer picture.
Know Your Staffing Needs
People-related costs are often the biggest expense of a business. With rising health care costs and the impact of complex employment regulations, you don't want to have too many people on the payroll or too much overhead until you really need them. Make sure your staffing plans are aligned with your forecasts and business plans.
Outside Help: Two Options
With resources such as SCORE and Visa Business, there is no reason for any business owner to go it alone when it comes to forecasting for their business. All it takes is a phone call, a few clicks of a mouse or stopping by your local SCORE chapter and the burden of trying to come up with a forecast that makes sense can be lifted.
- Another good source is your accountant and/or business advisor. If you’ve hired an individual or company to assist you with the financial aspects of your business, then you should contact them re: your business forecast. If you don’t have someone yet, but are looking to grow your business, it may behoove you to find that person prior to putting together your forecasts. This is, after all, their area of expertise.
Use the checklist below to help you do a better job in forecasting your company’s future.
- Download the Visa/SCORE Financial Management Workbook (available in English and Spanish) to help you better understand your company’s finances: http://www.score.org/resources/financial-management-workbook-VISA-SCORE
- Solidify your forecasting foundation
- Review your existing forecast for this year and make any necessary changes to reflect your current business conditions.
- If necessary, seek outside assistance if you have any questions or concerns about the forecast you put together for your business
- Set up a regular review period to determine which options you should consider for your forecast. Keep your finger on the pulse of what’s happening in your marketplace in order to respond accordingly.