Why financial forecasting is vital for your small business

Why-financial-forecasting-is-vital-for-your-small-businessForecasting is extremely important for any business, but unfortunately, many small businesses do not conduct this process. Business owners are often, quite understandably too busy solving problems and searching for the next sale and do not make time for forward thinking.

But in order to identify new opportunities and stay ahead of the competition, small businesses need to incorporate forecasting into the management process. Once they have put together projections, they can use them as a route map for strategy and decision making.

Throughout this difficult time for businesses, EFM has been supporting companies across multiple sectors and of varying sizes with their business survival planning, sourcing and applying for equity, loans & grants, and of course, most importantly, planning for the future through the power of the financial forecast.

If you don’t undertake this practice in sufficient detail and at regular frequency, your business may encounter serious and unexpected (and possibly avoidable with the advantage of early warning) financial issues which could result in lost profits, adverse cashflow, all leading to business failure.

But first…

What exactly is Forecasting?

Forecasting is a planning process that helps management better confront uncertainties about the future. It relies on past and present data to identify trends and uses these to project future outcomes. Forecasting different scenarios of the company’s future can be invaluable when  making key decisions, such as hiring staff, investing in new equipment, chasing new sales opportunities and investing in marketing.

Forecasts are used in a variety of ways within a business. Management might use a forecast to make decisions on pricing a large new contract or purchasing required inventory levels so as not to lose orders while avoiding tying up more cash than necessary in stock. Forecasts can also be used in the development of a financial budget, a cash management plan / plans or creating a pathway for the company’s short-term and long-term strategic vision.

Plan and predict your Cashflow

The expression “Cash is king” has never been more true.  A strong cash balance allows a business flexibility to grasp opportunities and weather unforeseen expenses or delays in receiving payments from customers. Keep your balance high and regularly monitor your forecasts.

If your cash flow forecast highlights possible gaps in your funding, consider what options are  available to you to fill them (don’t just think about bank loans, there are other options, such as invoice discounting or lease financing and these may be more cost effective, and you should also speak to your shareholders to assess whether they might be prepared to support your business) and make sure you allow time to get your application in and for the potential funder to go through its’ approvals process.

Pull together the documents a funder might require (e.g. recent bank statements, annual accounts and up to date management accounts) so they are immediately available and avoid wasting precious time.

For most small businesses, cash flow is a challenge.  You have more than enough cash flow one month and not enough cash flow the next. Forecasting allows you to predict and anticipate the peaks and troughs so you can assess what you can afford to spend and what cash needs to be retained in the business.

You might look at several years of data and realise that there is a pattern as to which months you have historically had a cash flow problem (this is sometimes referred to as seasonality within business cycles). You can investigate, so you understand why the issue is occurring, and find ways to limit the impact when it occurs in the future.

This may involve implementing new systems and processes – credit management policies, clearer terms and conditions of trade, streamlining the invoicing process to get invoices out as quickly as possible, obtaining facilities to cover seasonal challenges (e.g. customers being shut in August), new pricing (and possibly prompt payment discounts), quicker reporting and much more.

Make time to look at expense items the business is incurring and identify and eliminate any that aren’t critical to the business. Find out what notice period you are on (if any) and either cancel the service or give notice you intend to either cease or reduce the level of activity. For those cost items you can’t live without, consider talking to the supplier to see if they can offer you a better deal or, for more expensive items, put out a tender to see if you can obtain a keener price (you will need to weigh up the time involved in drafting and assessing a tender versus the potential cost saving).

If you are considering either reducing the hours staff work, their pay and benefits or making people redundant, make sure you take appropriate professional advice before acting, as mistakes in this area can be both expensive and time consuming to correct.  It’s also worth considering whether staff can be re-deployed to make better use of their time.

In summary, manage your cash balances so that discretionary spend is only allowed when you are reasonably certain you are holding sufficient cash back to cover any pinch periods identified in future months.

Helps determine long-term vision

With good / accurate forecasting you can create a long-term direction for the company to head in – essential even when day to day challenges seem more pressing. This is the overall vision for the organisation and can sometimes include the development of a mission statement (a document that sets out the overall high-level goals and objectives of the business). A long-term vision can is often look five or more years into the future and can be very broad.

They try to provide an overall picture of where the company wants to be down the road and should reflect the wishes of the owners, which might include a possible exit, or being able to generate a certain level of income. Importantly it then allows you to break down the steps on a year by year basis to move towards this vision, ensuring the right financial decisions are made at the right time and quick action is taken if plans start to slip or opportunities present.

Establish a pathway for achieving goals

As with any journey you undertake, you need a reliable map to know where you are going. A well thought out forecast will become the map you need to help you establish the short and long-term goals, and to create a pathway that allows you to achieve those goals.

In order to predict the future, you need to learn from and understand the historical data about your company and the market trends within the sector that your business operates in. Once the forecasts are developed, you will be able to identify attainable goals and have a high-level plan that shows how you could realise them. Often these are what are called SMART goals, which stand for Specific, Measurable, Attainable, Relevant and Timely. You want goals that are very specific and advance actionable ways to achieve those goals, and which can be assessed, so you can tell whether or not you have met them.

Provide investors with necessary information

Investors not only want to understand a business’ current financial health but also want to fully understand where a business is heading. For example, do you think it will take 18 months before a certain service reaches profitability? If so, you need a forecast that reflects that prediction. You need solid data on how you made the prediction – market trends, past performance, etc.

An investor wants to limit their risk when making an investment and a forecast will not only show them where a business is headed, but will also give them a clue as to how well you understand your business, as a robust and well thought out forecast will give you the opportunity to have a meaningful discussion of the drivers within your business and how your company sits within the sector within which it operates.

Helps identify risky and opportunities

Most business leaders will generally want to limit your risk and increase new opportunities. That’s how you succeed in business. Forecasting can help you flesh out unforeseen risk and identify new opportunities, as well as to help you prioritise / rank new business opportunities (as the forecast should give indicative levels of profitability, and your sector knowledge should enable you to assess the likelihood of success).

You will be able to better understand your customers and will learn ways to attract new ones with proper forecasting. You can develop sales plans to go out and market to those new customers, but you have to make sure your forecasting is accurate and does not make unreasonable assumptions.

This advice on best practice in forecasting for uncertain times will undoubtedly help you keep your business under closer control over the coming months. Whatever the circumstances you find your business in, know that you’re not alone – and that we’re here to support you.

If you would like to find out more about how EFMs bespoke, part-time financial management & business advisory services can benefit your business, contact the EFM team. Our EFM Experts can help you to construct & manage your financial forecast and business survival plan effectively. Get in touch via  clientcare@efm.uk.com or call 01582 516300 to arrange your free 1 hour 1-2-1 consultation.