Forecasting is a necessary part of any business plan. However, the process of putting an accurate plan together is often misunderstood.
Some view forecasting as a waste of time given the undeniable fact that reality never ever plays out according to the plan - and as such, they don’t take the process seriously, or maybe skip it entirely.
However, inaccurate forecasting is as bad as having no forecasting, as it can severely impact business performance.
Forecasting is a tool that business owners can use to make better decisions. Just as all Uber drivers have maps for where they are headed, every business owner should be forecasting their finances into the future.
In the first part of this two-part blog, we’ll make it easier for you, and give you some ideas on how to improve your forecasting accuracy. Here are the first four out of the eight ideas.
1. First ask why
The most important step before forecasting is to understand what purpose the forecast will be used for. Is it something that the business owner will look at after each month end and base decisions off? Will it be shared with the wider team on a quarterly basis? Is it simply for a bank loan application?
How much detail you need to go in really depends on the underlying purpose.
2. Finding the right balance
Forecasting comes at a cost, in either time or money depending on whether you do the forecasting work yourself or pay a third party to do this. If going for the latter, you or your team will still need to be involved in the forecasting process. The business owner and/or staff generally know what is going to happen next better than anyone.
The cost of a forecast depends on how scientific and detailed you get into each forecasting line. There is a balance here between:
- Turning over every stone, diving into the detail on every line and therefore incurring a large time/cost; and
- Taking a practical approach to reasonably forecast each line without incurring too much time cost
For example, you could forecast your revenue by estimating the sales of each product or service line by line, month by month – adjusting for seasonality. Or you could instead start with your total sales goal for the year and simply divide by 12 months. It really depends on the situation what is appropriate.
And sometimes, less is more. It depends on the complexity of the business. In some cases, a reasonable estimate can be just as good as a forecast that has been deliberated over for weeks.
3. Conservative v Optimistic
It pays to consciously decide where you are going to position the forecast on the optimism scale.
On one hand, you can produce a forecast that represents what would happen if everything went your way, on the other hand, you could assume the worst. This is really a matter of personal preference and professional circumstance. For example, an overly optimistic forecast might not get far through the bank loan application process.
If there is a halfway point on that scale, we generally position a little toward the conservative end, but not too far from the middle.
There is no point in creating a forecast that will put your resources under too much pressure. But at the same time, being too conservative encourages complacency - a killer in the digital age.
Set your sales targets at something that is achievable, but that still requires a good sustained effort from your team. And add a little fat into your expense forecasts to help plan for the unexpected.
4. Focus on the big numbers
For most small businesses in NZ there are a few key lines in a financial forecast, being:
People costs (wages, subcontractors, drawings etc)
Rent / Home office
Travel / Motor vehicle
Interest / loan repayments
Capital purchases (assets)
Specific businesses will have other big lines to take into account also.
The trick is to understand what lines in the forecast have the biggest impact and to focus the forecasting time and effort on those lines.
Stay tuned for part two of this blog where we explain the next four ideas to improve your forecasting game.