What is Small Business Forecasting and Why Does it Matter?
Expertise provided by Gary Puckett, BBSI Business Partner
Forecasting is a way for business owners to prepare for the uncertain future. It allows you to set your business goals and determine your potential revenue and costs, taking into consideration various elements, such as sales or revenue, people and their skills, operational costs, risk, and market conditions – all of which are integral to any small business’s success.
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What is Business Forecasting?
At the most basic level, forecasting is predicting your future financial performance based on past performance and marketplace trends. Forecasting allows you to plan for significant expenses, set realistic goals, and craft budgets that reflect them, all while ensuring you stay on track as you pursue these objectives. As a concept, it’s easy to grasp, but the process can be complicated.
Accurate forecasting requires you to compare a thorough analysis of past and present data (e.g., sales performance, marketplace trends) against your business goals for the next year, three years, and five years. Here are some questions to keep in mind while creating your forecast:
- How much money do I make in a year, and how much do I spend in a year? Your profit and loss (P&L) data should keep your goals attainable. Knowing you don’t have enough revenue to implement necessary changes to reach goals empowers you to set reasonable goals in the short term and save bigger ones for later.
- What is my business’s cash flow? Your business doesn’t necessarily need to generate profit to stay open. However, cash flow is fundamental to any business. You must be able to cover the cost of operations and pay your employees.
With realistic goals set, you can start leveraging forecasts for business growth. But before we get into how to do that, let’s clear up some differences between forecasting and budgeting.
What Is the Difference Between Budgeting and Forecasting?
Budgeting and forecasting both play critical roles in the success of your small business, and they’re closely related in terms of their purposes. However, they are not the same thing.
Forecasting operates on a broader, company-wide level. During a forecasting session, you will determine where you want to be at a given point in the future and work backward, assessing what your business needs to reach that goal.
In contrast, budgeting typically focuses on the departmental level, looking at variability within and between individual departments rather than the grand total of all expenses across the entire company.
Budgets also look at the details and specifics of departmental spending rather than estimates. They operate within the framework of forecasts — you can’t budget past them.
What Factors Impact Financial Forecasting?
As you forecast, consider these crucial factors:
- Operational costs: These include expenses like real estate, equipment, and the extra costs of an unpredictable supply chain. Your operational costs may or may not be consistent, so always consider the maximum costs your business may face.
- People: Consider the individuals you work with. What specific skills do they bring to your organization? What can you accomplish with your current team? Do you need to hire new employees?
- Sales revenue: How much money are you currently generating from sales? What changes or upgrades to the process can you afford, given your current level of revenue or profit?
- Market conditions: Take into account the fluctuating conditions that are out of your control, like inflation, supply, and demand, as well as how they might change over the next one, three, and five years.
- Risk: What risk factors are at play in your business? How much risk are you willing to take on? When you develop your forecast, always consider your risk tolerance and protect your financial and psychological well-being by only taking risks you’re comfortable with.
Keeping track of these factors, which impact all businesses, is critical. You’ll also want to monitor any niche factors specific to your business and its clients (e.g., location, industry, regulations).
Why is Financial Forecasting Important for Small Businesses?
Forecasting protects your cash flow, and your cash flow protects your business. But too often, business owners don’t forecast because they fear what they will discover. The process requires taking an honest look at your operations so you can make informed decisions, even if they’re difficult. Doing so will help you align your organization, gather consensus on goals, and constructively address pushback.
Creating a forecast as a team means moving toward a mutually-envisioned future in which everyone has a stake. It also helps your business pivot in the face of unexpected challenges. When factors shift, you can review your capabilities and make adjustments to stay on pace toward your goals.
A forecast is both a map and a model for how your business should operate in any situation. By aligning your business, you protect it — and yourself — from whatever the future may bring.
Best Practices for Small Business Financial Forecasting
Every business’s forecast is unique, and there’s no singular way to forecast effectively. However, there are best practices to keep in mind that will position your forecast (and business) for success.
1. Work Backward From the Future
When budgeting, you look at the present. When forecasting, however, you should look at your aspirations for the future. Start by determining where you want to be in a year, in three years, and in five years. Then, work backward from each of those points to determine what you need to get there, such as what operating costs and personnel are necessary to accomplish each successive goal. As you progress forward, meeting these benchmarks indicates healthy growth.
2. Use the Past to Understand the Present
Past events and data can tell you why things happened or why they are happening now. They provide insights into and help tell the story of your present situation.
If you’re just getting started with small business forecasting, you should ask yourself questions like:
- How have I overcome hurdles in the past?
- Which factors led to my past successes?
- Did I meet my forecasted goals? Why or why not?
Critically assessing your past not only allows you to understand the present; it empowers you to learn from your previous successes and mistakes to ensure you continuously meet forecasted goals.
3. Plan for the Good and the Bad
Use forecasting as an opportunity to determine what you will do with excess revenue and how you will face a downturn. Be sure you can answer these questions:
- Which investments do I make if my business outperforms my forecast?
- Where will I cut costs if I underperform?
Having these plans in place removes emotion from your decision-making process during times of heightened insecurity or confidence. Instead, you’ll continue acting as planned, without deliberation or hesitation.
4. Establish a Six-Month Runway
When financial experts and business owners discuss a “runway,” they’re referring to the amount of time you’ll remain in business when accounting for current operations and expenses. It’s a measure of your available financial resources that will allow you to adapt should anything unexpected happen (e.g., lost business). The next six months serve as your baseline runway period because anything less than that is considered operating “paycheck-to-paycheck.”
To ensure your small business maintains that six-month runway, you should have a line of credit. It will help you stay operational and continue building client relationships, whether or not cost-cutting or other minor changes are required. Even if your income suddenly stalls, you’ll still support the necessary cash flow to meet current expenses (e.g., employees, bills, vendors) without abandoning your forecast.
It’s important that this runway is a line of credit rather than a loan because you want the flexibility of choosing when to use it. A line of credit establishes a maximum borrowing limit and remains open, whereas a loan borrows the money upfront, and you must pay it back with interest.
5. Review and Update Your Forecast
You should also set aside time each month (or, at a minimum, each quarter) to review your forecast and determine whether or not you are on track. If not, adjust the forecast to reflect reality, then adjust your business practices to reflect the new forecast.
6. Don’t Do It Alone
Forecasting is a complex process, especially for small and growing businesses. To make it easier and more effective, you should seek a trusted professional who understands the process. Working with a qualified partner can take the stress out of business forecasting and help you see firsthand how exciting and empowering it can be to envision your company's future.
Forecast Your Business’s Financial Future With BBSI
An old adage asks, “Did I make it happen, or did I let it happen?” When you forecast, you make success happen. But if you let success happen without a forecast, you, fortunately, stumbled into it.
Without a detailed forecast for guidance, you can just as easily stumble out of success.
BBSI’s Business Unit Team will help you understand your goals and ambitions, along with the steps necessary to take you from your present reality to the future you envision. We put you in charge of your financial future, so you’ll never find yourself just stumbling into, or out of, success.
Contact your local branch today to learn more about how BBSI can help your business.
Disclaimer: The contents of this white paper/blog have been prepared for educational and information purposes only. The content does not provide legal advice or legal opinions on any specific matters. Transmission of this information is not intended to create, and receipt does not constitute, a lawyer-client relationship between BBSI, the author(s), or the publishers and you. You should not act or refrain from acting on any legal matter based on the content without seeking professional counsel.