Whether you run a 7-figure business or a small weekend side hustle, financial forecasting helps you to predict how your business will perform financially in the future. It helps you to plan ahead, set expectations and goals, make smarter decisions, and is necessary to have if you ever decide to raise funding for your business. Investors want to see your growth projections before they can decide they want to give you any money.
Any business owner or self-employed individual can make a financial forecast. While some methods of forecasting can be complex, creating a simple forecast doesn’t require a business or accounting degree, as much of it relies on just looking at your numbers, and making smart estimations and predictions.
What is a financial forecast?
A financial forecast is an estimation or projection of a company’s future financial performance based on historical data, current trends, and anticipated future events. It provides an outlook on key financial metrics such as revenue, expenses, profits, cash flow, and financial position over a specific period of time.
It’s basically like predicting the future of a company’s money situation and as a business owner, it helps you to plan ahead and make smarter decisions. Keep in mind, a financial forecast is never 100% accurate. Most of it is made up of just guessing and estimating numbers.
The different methods of creating a financial forecast
There are several different methods of making a financial forecast, some more complex than others.
Here’s a brief overview of the different methods. Don’t worry if these sound confusing, this is just an overview of the different methods used by businesses. I’ll share a more simplified method further down below.
1. Percentage of Sales Method
The Percentage of Sales method uses historical data and applies a percentage growth rate to forecast sales and related expenses. It’s a simple approach that assumes past trends will continue into the future.
Who should use it? This method is suitable when you have limited historical data or when you need a quick and straightforward forecast. It works well for businesses with stable historical trends and where the relationship between sales and expenses remains relatively consistent.
2. Time Series Analysis
Time series analysis involves analyzing historical data to identify patterns, trends, and seasonality. Statistical techniques such as moving averages, exponential smoothing, or regression analysis are applied to make future projections based on historical patterns.
Who should use it? Time series analysis is helpful when you have a significant amount of historical data and want to identify patterns, trends, or seasonality. It is particularly useful for businesses that experience cyclical or recurring patterns in their financial data.
3. Regression Analysis
Regression analysis explores the relationship between dependent and independent variables. It helps forecast financial variables by examining how they correlate with other factors. For example, a company may use regression analysis to predict sales based on variables like advertising expenses, economic indicators, or customer demographics.
Who should use it? Regression analysis is beneficial when you want to understand and quantify the relationship between different variables and make predictions based on those relationships. It’s appropriate for businesses where specific factors have a significant impact on financial outcomes, such as advertising, customer behaviour, or economic indicators.
4. Scenario Analysis
Scenario analysis involves creating multiple financial forecasts based on different scenarios or hypothetical situations. It helps assess the potential impact of various events or decisions on financial outcomes. For example, a company might create best-case, worst-case, and moderate-case scenarios to evaluate the range of potential outcomes.
Who should use it? Scenario analysis is valuable when you want to assess the potential impact of different scenarios or events on your financial performance. It helps in understanding the range of potential outcomes and making informed decisions under different circumstances. It’s often used in situations where there is a high degree of uncertainty or when strategic planning requires evaluating various possibilities.
5. Cash Flow Forecasting
Cash flow forecasting focuses on predicting the inflow and outflow of cash in a business. It helps determine whether a company will have enough cash to meet its obligations and make important investments. Cash flow forecasts consider factors like sales, expenses, accounts receivable, accounts payable, and other sources and uses of cash.
Who should use it? Cash flow forecasting is essential for businesses that need to closely monitor and manage their liquidity. It helps ensure there is enough cash available to meet obligations and make necessary investments. Cash flow forecasts are particularly important for businesses with seasonal or fluctuating cash flows.
6. Budget-Based Forecasting
Budget-based forecasting involves creating a financial forecast based on the company’s budget. It aligns the forecasted financial numbers with the goals and targets set in the budget. This method ensures that the forecast remains consistent with the company’s planned financial activities.
Who should use it? Budget-based forecasting is suitable when you want to align your financial forecast with the goals and targets set in your budget. It ensures that the forecast is consistent with the planned financial activities and allows for monitoring actual performance against budgeted figures.
7. Market Research and Trend Analysis
Market research involves gathering data on market conditions, customer preferences, industry trends, and competitive dynamics. This information is used to anticipate changes in demand, market share, pricing, or other factors that can impact financial performance.
Who should use it? Market research and trend analysis are valuable when you want to incorporate external factors and market dynamics into your forecast. It’s useful for businesses operating in rapidly changing industries or when there are significant market shifts or customer preferences that need to be considered.
The simplest way to make a financial forecast
If you’re looking to build a simple financial forecast that tracks your monthly profit, the following method is taught by Lorilyn Wilson, CPA, in Carry’s course, Taxes & Accounting Foundations For Business Owners. It’s the most suitable method for smaller businesses that just want to project a clear path to profitability.
Here’s how it works.
Step 1. Start with your net profit goal
Instead of starting at the top with revenue, start at the bottom with net profit. At the end of each month, how much money do you actually want to make? For example, let’s say you want to make $10,000. Then everything else that you consider in your forecast, you want to try and get to your $10,000 net profit goal.
Step 2. Make a list of all of your products and services
Next, list your products and services that will generate revenue – what are your revenue streams? For example, if you run a marketing and design agency, you might have revenue coming in from one-off designs, retainer editing work, consulting, and maybe you also do some brand deals with your design and marketing YouTube channel.
Step 3. Figure out your variable costs
Next, figure out how much it cost to deliver those products and services. Will you have to pay for software, employees? Each revenue line will have different margins. For example, for brand deals for your YouTube channel, there may not be any additional expenses since you already have purchased all the equipment to produce your videos and can just squeeze an extra few minutes for an ad in your videos. On the other hand, for design work, it may take several employees in your agency dozens of hours of work in order to deliver the final product to the client.
Step 4. Figure out fixed costs
Then, figure out what your ongoing overhead expenses are. These are expenses that aren’t tied to delivering a certain revenue stream, but are just expenses that you’ll incur just to be in business (ex. bank charges, meals, office supplies, etc).
Step 5. Run the numbers and play around with them until you hit your target goal
Next, analyze whether these numbers get you to your net profit goal that you set in the beginning of this exercise. If they don’t, it’s time to tinker with your numbers. Can you charge more? Can you deliver your product while incurring less costs? Keep changing things until you get to your net profit goal of $10,000.
Step 6. How much runway will you need to reach your goal, and where will the money come from?
If you don’t have an established business yet and you’re just getting started, figure out where the money will come from.
- How much money do you need to get to your goal?
- Do you have money coming in on day one or will you have to pay money to get things going.
- Will you fund the business, get a loan, raise money from friends and family?
- How much runway of cash will you need before you can be profitable?
Step 7. Figure out your cashflow
The last thing you need to forecast is timing. 60% of businesses who fail are actually profitable on paper, but they run out of cash. One of the most important things you need to learn as an entrepreneur is how to manage that cashflow. A forecast is going to clearly lay out month-by-month (or week-by-week) when money is going to come in for certain projects, and when money is going out for expenses. Being able to manage that cashflow will be the difference between you succeeding and failing in your business.
Step 8. Keep updating your numbers each week or month
Your forecast is never actually done. Every week or month, you’ll have new information that you can update what your forecast says — this is a rolling forecast. Always revisit your forecast and update your assumptions according to what’s changing in your business.
As things change in your business (for example, you have more revenue coming in or you hire a new employee), you want to update your forecast accordingly.
Master the fundamentals of business accounting
Financial forecasts are important for the company itself to plan its operations, and they can also be shared with investors or lenders to show them what the company expects to achieve financially. Remember, though, that forecasts aren’t set in stone. They’re just educated guesses based on the information available. Things can change, unexpected events can happen, and the forecast may need to be adjusted along the way.
Financial forecasting is just one method you can use to get your business to profitability more efficiently. In our Taxes & Accounting Foundations For Business Owners course, you’ll learn about the best business entity to choose for your business, different accounting systems, bookkeeping basics, deductions, and how to avoid getting audited by the IRS.
You’ll also get access to my financial forecasting template as well as a number of other bonus resources and workbooks.