You might see forecasting as a waste of time, or something you do when you have absolutely nothing else on your plate (which is, um, never). Or you may have been diligently forecasting each month in the past, and stopped once you found that reality turned out quite differently to your best laid plans.
And who can blame you?
We’ve seen many of our customers thrive by harnessing the power of regular forecasting to make better decisions. But it’s often missed, or misunderstood. Think of it as your company’s GPS – you have to know the destination to get to the right place. Inaccurate, or no forecasting can be like driving with the handbrake on.
There are a number of benefits to building out monthly cash flow projections. Regular forecasting gives you valuable insight into how much money is coming in, what’s being paid out, and when it’s likely to happen.
A financial forecast for your business can give you time to respond to issues before they become problematic. And tracking your finances over time will help you understand the big financial picture, so you can grow your revenue and your profits.
We want you to feel confident to forecast your cash flow, expenses and profits. Using eight key steps (the first four are below) will give you a clear sense of why forecasting is important, what to focus on, and how to get the best out of it.
In part 1 of this 2-part series, we’ll give you some ideas on how to improve your forecasting accuracy, while making it feel easier too.
1. Decide what you’ll use forecasting for
Will you look at the forecast each month’s end and use it to make decisions for the upcoming month? Will it be shared each quarter with the wider team? Is it simply for a bank loan application? The answers will determine how much detail you need to go into.
2. Figure out the ‘who’ and ‘how’
Forecasting comes at a cost, (in time, money or both). If you plan to engage a third party to do the work, you and/or your team will still need to be involved in the forecasting process, as you know the business better than anyone.
Consider also how scientific and detailed your monthly forecast will be. For example, you could forecast your revenue by estimating the sales of each product or service line by line – adjusting for seasonality. Or your revenue projections could start with a total annual sales goal, divided by 12 months. A reasonable estimate that helps you respond quickly might be better for your business than a forecast that’s been deliberated over for weeks.
How to get your cash flow and budgeting basics sorted by asking these 5 questions.
3. Glass half full, or rainy day?
It pays to consciously decide where you are going to position the forecast on the spectrum between conservative and optimistic: i.e. a forecast that represents what would happen if everything went your way, or assumes the worst. An overly optimistic forecast might trip up your bank loan application, while being too conservative could breed complacency. We suggest erring a little toward the conservative end of the middle.
If you’re more ‘optimistic’, try to avoid forecast numbers that are too high. Set your sales targets to be achievable, but challenging. This may be a time to look at your incentive structure (if you have one). And add a little fat into your expense forecasts to cushion you against the unexpected.
4. Focus on the big numbers
For most small to medium New Zealand businesses, these are the key lines in a financial forecast.
- People costs (wages, subcontractors, drawings etc)
- Rent / Home office
- Travel / Motor vehicle
- Interest / loan repayments
- Capital purchases (assets)
Depending on your business, there could be other big lines to take into account too. You may have significant material costs, for example. When you understand which lines have the biggest impact, you can focus more time and effort on those lines.
Read Part 2 of this article here.