It's a rare entrepreneur who enjoys working on financial forecasts. Many feel that their time is better spent on developing and running their business. Still, forecasts are a necessity. Entrepreneurs need them to attract investors, but more importantly they help the business owner develop long-term strategic plans.
Unless the forecasts are fairly accurate they are not at all helpful. Inaccurate forecasts can lead to upset investors, mismanaged expenses, and potentially running out of cash. Here are six tips to help you make your forecasts as accurate as possible:
1. Use multiple scenarios. Every business owner has a strong temptation to be optimistic when forecasting growth. To counter this, many entrepreneurs end up using extremely conservative estimates. In reality, neither is the only option you should forecast. You should devote your predictive energy to at least two scenarious, one optimistic and one conservative. This is especially true when there is uncertainty surrounding major factors that can impact your growth.
2. Start with expenses. It's generally much easier to predict your expenses than your revenue. Start building your forecast model by outlining your fixed expenses, things like rent, utilities, and insurance. You can be almost certain these costs will occur in the coming quarter/year. From there think about the costs that could fluctuate directly with revenue. If revenue grows by five percent, you can probably expect your cost of sales to grow by about five percent. Finally, project the expenses over which you have the most control. This is the one place where multiple forecasts can come in handy. Identify which discretionary costs you might slash if business is rough or where you will invest for future growth if you exceed expectations.
3. Identify your assumptions. Any forecast requires you to make assumptions about things that are outside your control. The best way to manage these assumptions and avoid subconscious bias is by explicitly identifying and writing them down. The assumptions you should list include how much the market will grow or shrink, changes in the number of competitors and technological advancements that will impact your business.
4. Outline each step in your sales process. Your revenue projections should go through the entire funnel of your sales channel rather than just guessing a top-line number. You should create projections for each step of the sales funnel, and use that to arrive at the top-line number. As an example, the revenue projection for a pet supply store might involve the following steps:
a) identify the total number of pet owners in the area,
b) estimate what percentage of that market can be reached through marketing efforts,
c) estimate what percentage of pet owners exposed to the marketing actually come in to the store,
d) estimate what percentage of people who come into the store will make a purchase, and
e) estimate how much the people who do make a purchase will spend on average.
5. Find Comparisons. You can assess the plausibility of your financial forecasts by comparing your projections to the results of comparable companies. Look at certain key financial ratios such as gross margin, revenue per square foot (for retailers), and total headcount per customer. If your projections include one of these ratios improving by over 10 percent, you might be getting too optimistic.
6. Constantly reassess. These forecasts should not be static. Don't make on at the beginning of the year and forget about it over the next 12 months. Regularly evaluate how close your operating results mirrors those forecasts and make changes to reflect any new information. The more up to date your forecasts are the better prepared you will be to make informed, strategic descriptions. Also, you will become more skill in the process over time.
Are you operating a small business and would like to discuss forecasts with a knowledgeable Business Consultant? Give us a call 281-488-2022, we're here to help.