How to create a financial forecast: Some key tips
Posted: Thu 20th Aug 2020
What really makes a difference when it comes to making effective financial projections for your business?
The truth is no-one has a crystal ball. So remember that, strange as it sounds, financial projections aren't actually about predicting the future.
In fact, they're about understanding and communicating the key financial issues you face. They're a map of the territory, not a roadmap. So just as you have a written business plan which is a vision or story of a possible future, you need to tell the financial side of that story and show it all adds up.
Preparation
Before you start work on your numbers, focus on why you're doing it. You produce financials for two reasons:
First it's to understand your own finances. Financial projections help you see how the numbers of the business work, whether they are viable, and what your main financial issues are.
Second, it's to communicate those numbers to someone else, usually a bank or investor. If any aspect of your forecast doesn't contribute to these objectives, think again.
Keeping the objectives in mind should help you avoid the worst mistakes you can make when putting together numbers.
Six important things to consider with financial projections
Own your numbers!
We've all seen Dragons' Den. You know what happens when you don't understand your own numbers; it's never pretty!
Never subcontract the entering of your numbers to someone else, even if they're your trusted accountant. You have to own your numbers and understand each single entry, and the only reliable way is to input each one yourself.
It's why in our business when we create forecasts for clients we never provide finished numbers for them.
Get the level of detail right
Ask what level of detail is actually useful: both to you and to your reader. Too much information is as bad as too little.
Going into too much detail, especially around projected figures that you're really guessing at, isn't usually helpful. If it doesn't aid your understanding, or tell the reader something useful, simplify it.
At the same time, make sure your model is comprehensive and transparent. Always ask if it raises more questions than it answers. And seek help if you're not sure what to include or how to present it. Don't just guess!
Know your 'opening balances'
The first fundamental of any forecast is 'where are we now?'. In other words, the current financial position, or what are usually known as the 'opening balances'.
Even if you have just a few simple balances before your forecast starts, it's important that you state them clearly, in proper accounting terms, and they are as recent as possible. It's not acceptable to start a forecast three months ago because that's the last time you did your bookkeeping. Get it up to date!
'Model' your revenue and direct costs and make your assumptions clear
All revenue is a product of 'activity': for example, 'number of units sold at an average price of...' etc. Projected revenue should be shown as the result of these assumptions.
Only when you do this can you understand how plausible your revenue projections are. The same is true for your reader. Straightforward 'budget' projections directly inputted as financial values are usually acceptable only in the most basic start-up projections.
The same is true of 'direct costs' (or 'cost of sales'). These costs relate directly to revenue on the basis of some assumption (for example, credit card commissions may be an average of, say, 2.5% of revenue). Again, you should model this cost on the basis of this assumption. Apart from anything else it's useful if your direct costs respond automatically if you change your revenue projections.
And, importantly, make sure to set out all your key assumptions clearly somewhere in the final reports.
Create separate profit and loss, cash flow and balance sheet elements
Business finances are made up of three elements:
Balance sheet
And they all do different things. Financials without all three are simply not complete and will never tell the whole story, even if your business is small and just starting.
You've (hopefully!) got a long career in business ahead of you, and you're going to need to get to grips with this stuff sooner or later. So learn the basics and don't just ignore them. It's worth it in the long run.
Produce readable and legible reports
Remember that you're usually doing this to give these numbers to someone to read! You'd be amazed how many people spend weeks constructing the most convoluted spreadsheets without giving a second thought to actually being able to produce anything someone can read.
Make sure the document is properly paginated, clearly labelled and actually legible both on screen and when printed. Always create a PDF file and never circulate a raw spreadsheet unless someone specifically asks for it.
Do it for yourself first, and the lender or investor second
So often, businesses produce financial forecasts just because a lender or investor has demanded them. But if there's one person who has more need to understand the basic nature of your business finances and whether it looks viable, who has more invested in its future success and who is more dependent on it, it's you!
Even if you're not looking to raise money, even if you think it's really small and can't go wrong, create a simple financial model for your business and run the numbers. For your own sake!
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