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How To Create A Financial Forecast

Running a business is tough, and trying to figure out what the future holds can be more of a mystery than anything. Planning has always been a point of emphasis for what startups and small businesses need to do. Putting together a business forecast can be difficult. Most business owners start out trying a spreadsheet or just a pen and paper. As long as you have an understandable and achievable goal, a variety of methods can work. The important part is just getting it right.

What to include in your financial forecast?

The most important aspect of your financial forecast is to clearly define your expenses. The easiest way to do this if you already have an existing business is to look at all of your current expenses. Decide which ones will stay the same and which ones will increase over time. If you are just starting a business, do your best research and use estimates.

Categorizing expenses

Once you’ve identified a decent list of possible future expenses, you need to determine which ones are fixed and which ones are variable. Don’t stop reading yet, it is simply done by asking yourself one question. “If I sell just one additional product/service, does this expense go up?” If the answer is yes, then it is a variable cost. If no, then it is a fixed cost. So why is this important? In order to calculate forecast easily, calculate break-even, know how much you can pay yourself, and other business decisions; you need to have your business expenses broken down into these two categories. After forecasting expenses you should look at your sales forecast and projections. See that wasn’t too bad.

In summary:

Variable Costs increase when you sell more. Examples of these include, product costs, credit card fees, shipping(if you pay and not the customer), packaging, etc.

Fixed Costs should stay the same throughout time. Examples include rent, utilities, subscriptions, legal costs, insurance, employees, etc.

Sales Forecast and Projections

After planning all of your expenses, now it’s time to look at business revenue. Ther terms sales and revenue are almost interchangeable. What you need to know is this is just the money you are making when you sell and provide what your business offers. When you estimate future sales, try running a few different scenarios. For example, if things work great, are average, or if things get bad. By running a few different forecasts you can see exactly what you would need to do if different scenarios end up happening. If the only forecast that looks good is if things look great, you may want to plan your business differently to prepare for the unexpected.

Although I can’t provide statistics, nobody starts a business and plans to fail. It happens because of a host of problems arise. Maybe a decrease in sales, insurance costs are higher, employees want health care, running out of cash, or maybe you are just expanding too quick. Either way as an entrepreneur you have taken on a huge task of running a small business. Forecasting is your best defense to plan for the unexpected and to be prepared. A business plan also helps with addressing specific issues which is why these work hand in hand.

Tying Sales to Variable Costs

Whether you are using a spreadsheet or a pen and paper, as you forecast your sales you need to make sure that sales are tied to your variable expenses. If you sell a product for $20 and you have variable costs of $10, make sure that as you forecast future sales, that you also predict your future variable costs each time you make an additional sale. Make sure that each time sales increase that your variable costs increase. You are almost at the finish line for doing a financial forecast. See the example from www.startegy.com below.
variable costs

Increasing fixed costs

As you run your business there are other factors to consider. When will you need to upgrade your work space. Do you need additional insurance? When can I hire another employee.

As you grow and expand your business in your financial forecast, you also need to look out for your fixed costs increasing. Naturally as your business grows you may pay for more employees, bigger buildings or office space, management softwares, or a number or other fixed costs.

Check your performance

Once you have added all of your sales, variable costs, and fixed costs you can now see how everything is running. The best tracker for operational performance is the net income statement. Many banks require you include this in your request to get a business loan, line of credit, or other forms of funding. They will want to see what is called a pro forma net income statement or a profit/loss statement. Shortened they may refer to it as a P&L statement. Either way don’t let this put a burden on why you are doing a forecast. If you have done the things above correctly, this shouldn’t be a problem.

I’m not going to get into depth, but all a net income statement is is a breakdown of Sales, Variable Costs, and Fixed Costs. If you don’t feel this is something you are comfortable doing, the free version on startegy.com will allow you to generate your pro forma net income statement for free. See example below.
net income statement

Another way to see your performance is to use graph out how your business is doing. As you look at revenue and net income for each month, you can get a better glimpse of the possible success of your business.
revenue and net income chart

Anytime your net income is below “0” this should be something to look at further. You can only lose money for so many months until you are out of cash to keep your business running. This brings us to the next step in the forecast.

Forecasting Cash Flow

Believe it or not, many successful businesses aren’t profitable right away. Tesla, Facebook, and, Amazon are some of the biggest companies that lost money for quite some time before being able to turn a profit. How did they do this? Cash, that’s how. If you have enough loans, financing, lines of credit, or other funding; then you can keep your business going through the hard times. Most startups aren’t profitable right away because it takes a while to get operations running smoothly.

How does this apply to you as an entrepreneur? Guess what, you have another responsibility to add to the already hundreds that you have. Always be aware of your cash position. When I say cash position, I’m referring to always being able to pay bills, buy materials or what you need to make and provide your products and services; most important, be able to pay yourself and your team. Remember that when you borrow any money, calculate the payments you need to make based on the interest rates. www.startegy.com has an easy process to add cash or funding or debt and also manage payments. You then can see what your cash forecast is.
cash on hand chart

Once you have forecasted all of your fixed and variable costs, sales, and cash flow, you can now look at other metrics to help you manage and forecast better. Some of these include, net profit margin, break-even analysis, and testing different pricing strategies. I won’t get into these here but we will have other articles to better explain how these all fit into a financial forecast. Wish you the best on your business endeavors. If you need help with a financial forecast or business plan, sign up at www.startegy.com.

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Chief Financial Officer