Knowledge is power – and while the advent of the crystal ball isn’t exactly around the corner, it is fair to say that forecasting the financial performance of your business is not only achievable, but should be an integral part of the way you operate. Successful business owners understand the importance of using historical data, strategic planning and sound forecasting to set their business up for success. In this article, we’ll explore why forecasting is important, what financial metrics are used, and how you can harness the power of the data it ultimately produces.
forecasting – why it’s important
What makes forecasting so important to a business is pretty simple. It provides guidance, structure, and preparedness in running your business – an environment in which uncertainty is often present. Thorough forecasting gives business owners the advantage of clarity in being able to work towards desirable outcomes by using data and planning to predict, with reasonable accuracy, the likely financial position of the business across a predetermined period of time (often 12 months, the timeframe to be used in the examples in this piece).
With this information, businesses can make important decisions, particularly around growth, maintenance, succession and/or major investment. Forecasting data is also important for other aspects of business including finance applications, as lenders want to know how your business is tracking over time before approving a commercial loan application.
forecasting – the financial metrics
Forecasting for your business incorporates a range of financial metrics to ensure all the bases are covered, giving you confidence and a 360-degree view of your business and where it is headed. Three-way forecasts are a common and reliable way to monitor and track business performance. Three-way forecasts include the following elements:
Profit & Loss Forecasts: Profit and loss (P&L) forecasts, as the name suggests, looks to predict your business’ profit and loss over the next twelve months. It factors in things like predicted sales (less discounts and cost of goods sold), income from dividends and interest payments, staff wages, regular business expenses such as bills, and a whole range of other items typically found on your P&L statement. This data is then extrapolated over twelve months, sometimes commencing from the next financial year, to determine what the likely profit or loss situation will be at that time.
Cash Flow Forecasts: Cash is king. In business, having sufficient cash on hand when you need it is critical, and comes from being well-prepared with cash flow projections. McKinley Plowman’s free cash flow projection template lets you input your sales figures for up to a two-year cycle, as well as your other incomings and outgoings, presenting you with an overview of your cash flow. When it comes to slotting this into a broader three-way projection, you can input figures you think might be achievable (or figures you’d like to see), and see where your cash flow fits into that and develop strategies to smooth out any periods of particularly high or low cash flow.
Balance Sheet: A projected balance sheet is a useful tool to be able to see the estimated assets and liabilities of your business in the future. This is particularly relevant when it comes to applying for finance to invest in your business (e.g. for fixed asset purchases), a projected balance sheet is a must-have.
forecasting – what can we achieve with this information?
It’s all well and good to have this information to hand as a business owner, but how can you go ahead and apply it to your business in a practical sense? There are many influencing factors that will affect how you might interpret and leverage forecasting data. For instance, if you are in a growth phase, you might use forecasting information to set goals for future growth, i.e. outline the figures you’d like to see in 12 months, compare that with the projected figures, and develop strategies alongside your business advisors to bridge any gaps. Alternatively, your business might be struggling, and projected figures from your forecasting activities may paint a pretty dire picture. In this situation, you could use the data to determine where the major shortfalls are likely to be, and proactively make changes to give you the best chance of turning your business around.
how mp+ can help
Getting into the granular financial information required to accurately forecast business performance is not only a difficult process for many business owners, the vast majority simply don’t have the time. McKinley Plowman can provide you with clarity in three-way projections and advise you on how to make the most of the information that arises. From here, you can be confident that you have laid the foundations for success and prosperity over the next 12 months and beyond.