Preparing Financial Forecasts That Make Sense
Many believe that financial forecasts are more of an art than a science; however if completed correctly financial forecasts can be a valuable tool for the development and growth of your business. Financial forecasts are generally prepared by business owners for two purposes, investment or strategic planning.
Why Prepare Financial Forecast
Preparing financial forecasts for the purpose of securing investors or bank finance is self explanatory. In these circumstances your forecast will form part of your business plan and should assist the reader in understanding how your business will provide them with a return on their investment or meet the loan repayment requirements.
When used as a strategic tool, the process of preparing financial forecasts alone is valuable to a business owner as it will allow you to understand not only your business but your industry as a whole. The forecasts you prepare will provide you with a set of targets, along with a method of identifying difficulties which may arise in future months and how such issues can impact your business. By identifying such issues before they arise, you can put corrective measures in place at an early stage to mitigate the impact on your business.
Preparing Effective Financial Forecasts
There will be number of steps to be completed when preparing a financial forecast and it may be advisable to consult with your financial advisor as they should have a good understanding of your business, along with significant experience in preparing forecasts. From our experience of working closely with our clients we have outlined below some of steps which will assist you in preparing your financial forecasts.
- Understand Your Costs
It may seem like unusual advice; however starting with your costs is best, as you will have some element of control over these. Costs should be broken into the following categories:
|Fixed Costs||Variable Costs|
|· Wages and Salaries||· Production Materials|
|· Rent and Rates||· Production Supplies|
|· Insurance||· Direct Sales Costs|
|· Accountancy/Professional Fees||· Packing|
|· Print, Postage and Stationery||· Distribution|
|· Loan Repayments||· Marketing|
Fixed costs are those which remain relatively consistent regardless of your sales; however as your business grows increases in fixed costs will need to be considered for items such as salary increases, in line with increases in standards of living, or rent increases for changes in rental markets or expansion.
Variable costs on the other hand are directly linked to your sales and should be included in your Cost Of Goods Sold (COGS) to provide you with your gross profit. Your fixed costs will then be deducted from your gross profit to provide you with your net profit.
- Forecasting Your Sales
Forecasting your sales is always going to be difficult; especially if you are a start up business. While you will want your business to show progression and profit you will not want to reflect a sales level that will be perceived as unrealistic. Some business owners prepare two sets of financial projections, one which would represent conservative figures and one which represents the potential which your business could achieve if you allow yourself to think big!
Some key questions to consider when forecasting your sales are:
- What sales/leads levels will be achieved per month?
- How will you source these sales/leads?
- How will you convert the sales/leads?
- How much will it cost to convert the sales/leads?
If you are an existing business a good measure of your future sales will be your past performance. Reviewing sales levels of previous months and years will allow you to identify possible trends within your sector which you will need to consider. For a forecast to be meaningful, it is also advisable analyse your various sales channels as this will provide you, or a potential investor, with a clearer picture of how the business will achieve its expected turnover.
- Prepare a Cashflow Statement and Balance Sheet
Once you have determined your income and expenditure levels you will now be in a position to prepare a cashflow statement, which will reflect your cash inflows and outflows. When preparing a cashflow you will need to be realistic in your estimates of when you expect people will pay, as not all customers will pay within the thirty day credit period. Unlike your income and expenditure, a cashflow statement will also take into consideration movement on your balance sheet such as the repayment of loan capital, as only the interest element of your repayment will be included in your income and expenditure. By preparing a cashflow statement you will be in a position to determine periods when cash will be low or where you may have a surplus. Being aware of these periods ahead of time will allow you to better manage inventories and stocking levels so that you keep your business cash positive, which is key!
Effective financial forecasts will also include a balance sheet which will allow you to determine the asset, liabilities and net worth of your business. Examples of items included in your balance sheet are fixed assets, closing stocks, creditors and loans balances due.
Using Financial Forecasts To Advance Your Business
Preparing meaningful financial forecasts will take some time so it is vital that once they are prepared you get the most out of them. Don’t just leave them in a filing cabinet. You will need to review, track and measure your forecasts against your actual results on a regular basis, with some suggesting a monthly review. By completing such a review of actual v’s projections on a regular basis you can determine the areas of your business which are functioning well and more importantly the areas which are not. Identifying problem areas at an early stage will allow you to put preventative measures in place to manage and reduce the risks identified.
As outlined above, as you continue to monitor and update your projections you will enhance your knowledge of not only your business but your industry as a whole, which will give you a significant advantage over your competitors!
If you would like further information on preparing or reviewing a financial forecast for your business you can contact us here.