Understanding Financial Forecasting for Small Businesses

As a small business owner, you wear many hats—from CEO to customer service. But one of the most important roles you play is that of a small business financial planner. Financial forecasting is a key skill that can help your business thrive. Let’s break down what financial forecasting is, why it matters, and how to do it.

The basics: What is financial forecasting?

Think of financial forecasting like creating a budget for your business. Just as you might plan out your personal expenses (how much you’ll spend) and income (how much you’ll earn) for the year ahead, financial forecasting does the same for your company. It’s a way to estimate your future sales, expenses, and overall financial performance.

Why financial forecasting matters for small businesses

With all that’s on your plate as a small business owner, you might be wondering why you should bother with this type of number crunching. Here are a few key reasons financial forecasting is crucial:

• Planning for growth: Forecasting helps you set realistic goals and helps you plan how to achieve them.
• Managing cash flow: By predicting upcoming expenses and revenues, you can avoid cash crunches. This is especially important for seasonal businesses.
• Preparing for challenges: Forecasting forces you to think through potential hurdles and how you’ll overcome them.
• Making smarter decisions: With a clear picture of your financial future, you can make more informed choices about hiring, inventory, marketing spend, and more.
• Qualifying for financing: Lenders want to see that you have a solid grasp on your finances. A well-thought-out forecast shows you’re serious and have a plan for success.

Your financial forecast and business plan work hand in hand. Think of your business plan as a roadmap for your company’s future. It outlines your goals, strategies, and how you’ll achieve them. The financial forecast is the numbers behind that plan.

Key components of a financial forecast

At its core, a financial forecast is similar to a profit and loss statement (P&L), but rather than providing a snapshot of past business performance, it projects what is likely to happen in the future. The main parts of a financial forecast are:

• Sales/revenue: Your best estimate of how much money your business will earn
• Expenses: Your best estimate of costs associated with running your business
• Profit: What’s left after subtracting expenses from revenue

How to create a basic financial forecast

Creating a financial forecast might sound intimidating, but it doesn’t have to be complicated. You’re essentially making educated guesses about your future financial performance based on what you know now. While it won’t be perfect, the process itself is valuable. It forces you to think critically about your business and make concrete plans for the future. Let’s walk through the basic steps to create your own financial forecast:

1. Gather historical data: Look at your past financial statements. This gives you a starting point and helps identify trends.
2. Identify patterns: Consider factors like seasonality, economic conditions, and industry-specific trends.
3. Make reasonable assumptions: Be optimistic, but realistic. It’s better to plan conservatively.
4. Estimate sales: Based on your historical data and market analysis, project your revenue for each month.
5. Calculate expenses: List out all anticipated costs. Don’t forget to factor in any planned changes, like hiring new staff or moving to a bigger location.
6. Put it all together: Subtract your projected expenses from your projected revenue to estimate your profit (or loss) for each period.
7. Regularly update and adjust: Your forecast isn’t set in stone. Review and revise it regularly—quarterly or at least twice a year—to keep it accurate and useful.

How far into the future should you forecast? It depends on your business and goals. For startups 5-year forecasts are common and for established businesses: 2-3 year forecasts are often sufficient. Lenders may have different preferences based on your business stage, so if you’re applying for a loan, be sure to get their advice.

Getting help with financial forecasting

If all this number crunching feels overwhelming, don’t worry! There are resources available:

• Your accountant: They can provide valuable insights and help you create realistic projections
• Community organizations: Many offer courses on business financials, including forecasting.
• Small business development centers: These offer free or low-cost assistance to entrepreneurs
• Lending programs: Many small business lending programs, like those offered by Grow America, come with support on topics like financial forecasting.

Remember, you don’t have to be a financial wizard to create a useful forecast. Start simple, be consistent, and your skills will improve over time.

The bottom line on financial forecasting for small businesses

Financial forecasting might seem daunting at first, but it’s a crucial tool for small business success. By taking the time to look ahead and plan, you’ll be better prepared to handle whatever challenges and opportunities come your way. So grab your calculator, dust off those financial statements, and start peering into your business’s future. Your future self (and your bottom line) will thank you.