Accounting is commonly referred to as the language of business. With that said, it’s easy to understand why having accounting procedures is a very important part of knowing how your business is performing. Without strong procedures in place on how to financially track and manage your business, you can limit your company’s optimal performance. However, having current financial numbers is not the only way to maximize business performance; creating a financial forecast can help, too.
Financial forecasting is also commonly referred to as developing a pro forma or creating financial projections. However, in simplicity a financial forecast is really just the creation of financial reports that give the future financial outlook of what your business could be. These reports typically include a projected income statement, a projected balance sheet, and a projected cash flow statement.
Over the next few paragraphs, I will discuss in more depth some of the benefits of creating financial projections, as well as listing some of the information needed to create them.
The benefits of creating financial projections can be realized in many ways, including the following:
- Developing specific strategies and goals. They help you set standards by which to operate your business and also help with setting targets to achieve. Things like budgeting and sales volume are all impacted by understanding what the predicted future can look like.
- Helping evaluate expectations of a business owner related to the feasibility of what they’re trying to do. Forecasting can help the business owner realize if his or her expectations are achievable based on the information that was collected for the forecasting process. It’s not uncommon for a business owner to find that the numbers just don’t add up. Realizing this thus helps to prevent missteps.
- Making a business owner more informed about his her overall industry. In order to do projections, research must be done that typically requires a business to search for information both inside and outside of their business. This may include things like competitors and trends that are taking place in their industry.
- Providing solutions for the current issues a business might be facing. To create projections, a business owner typically needs to review some of the processes that impact the firm’s current financials. When completing this task, it’s not uncommon to find areas for improvement.
As you can see, there are clear benefits to forecasting; but in order to forecast and see the impact of these benefits, some research has to be done. Below are some of areas that must be researched in order to achieve the most accurate forecast:
- Future monthly operating expenses: what are the future monthly bills that will be recurring? This would include things like utilities, insurance, payroll and other bills that the business will pay in the future.
- Projected sales revenue: what are the future sales goals? Whether it’s monthly or on an annual basis, a business needs to understand what its potential income will look like and have details on how it will achieve these numbers.
- Future revenue streams: from where and from what areas will the projected sales come in the future? Typically a business gets revenue from several different areas. For example, a restaurant might project revenue from three different sources—food, alcohol sales, and selling merchandise.
- Cost of goods: this number represents any material cost attributed to sales and is based on a percentage. For example, for every dollar a restaurant earns selling food, it might cost them 30 cents in materials/ food product. Using this scenario, the cost of goods sold as a percent is 30 percent ($1 in sales divided by 30 cents in food supplies).
While the list above does not encompass all of what is needed to create projections, it does include some of the key information required.
If you are in the realm of wanting to learn more about, or need help with, creating financial projections, the ISBDC network is here to help. Our business counseling services are available free of charge to any small business in Indiana; click here to connect with the ISBDC and become a client.