The Small Business Owner’s Guide to Financial Forecasting
Updated: Dec 6, 2022
Financial forecasting is the process of estimating a company’s future performance based on past, current, and expected financial information. As a business owner, the success of your business is heavily dependent on your ability to plan. As such, it is important to allocate time to create and manage a forecast, and to regularly compare it to your company’s actual performance to make sure the company is achieving its financial and operational goals.
Companies can create short-term and long-term financial forecasts. Small business owners should create financial plans that forecast for a minimum of 6 to 12 months. Most business owners make forecasts that stretch even further into the future not only for internal purposes, but also because most banks and investors want projections that cover periods of 2 to 5 years.
The first step in creating a financial forecast is to define its objective and time frame. The next step is to gather historical information from the three major financial statements: the income statement, the balance sheet, and the statement of cash flows. This step is possibly the most consuming one as you have to make sure that the data that goes into your financial forecast is both complete and accurate. After you have gathered all past financial statements and historical data, the next step is to determine the forecasting method that will be used. You can use the quantitative method, the qualitative method, or a combination of the two. The quantitative method relies solely on historical information to predict future performance. The qualitative method is more subjective and is based on the opinion and judgment of consumers and experts. Quantitative forecasts are a great option if you already have a considerable amount of data to analyze. However, if your business lacks financial historical data, a qualitative approach may be the better option. The final step is to create pro forma financial statements using your assumptions and projections and to monitor your results over time.
There are several solutions to assist business owners with the preparation of a financial forecast. One option is to enter your historical information into an accounting software that will then calculate and generate projected financial statements. The advantage with this option is that it reduces potential human error and offers considerable time savings. Another option would be a more manual option, using excel spreadsheets to create your financial forecast. The advantage of using this option would be more control and ability to adjust the financial projections, which may not be an option when using an accounting software. A third option is to hire an accountant to prepare and manage your financial forecast. The advantage with this option is that you can focus your time on running your business while your accountant delivers a finished product to you along with expert advice and/or suggestions.
At CPA by Choice we understand that this process can be extensive, if you are unsure on how to get started or need assistance, contact us. We are available to answer your questions, feel free to call us or send us a message.