Jennifer Bailey, chief executive of footwear company Calla Shoes, admits she found creating financial forecasts a daunting prospect when she first set up her business. But as she’s learned over the years, it's a vital practice for a successful enterprise.
Among many other benefits, financial forecasts help you monitor your cash position (the amount of cash you have on your books at any one time), as well as providing you with data and metrics that will assist you in making informed business decisions such as when to invest, and the types of targets you wish to set yourself.
In this article, we explain how different types of forecasts work, and how to use them successfully.
What is financial forecasting?
Simply put, financial forecasting is a way of predicting how a business will perform in the future. It involves analysing past business performance – including revenue, cash flow and expenses – current business trends, and other factors. While the process will naturally involve some conjecture, an effective forecast should lead to improved decision-making.
Why is financial forecasting important?
Financial forecasting is crucial for business owners to understand how their business is performing and where it is heading.
According to Lucy Gordon, director of financial modelling experts Farley Cove, the biggest reason to forecast your finances is to monitor your cash position so that you can plan for all eventualities. This is important because cash flow problems are often cited as a significant factor surrounding UK business failure. [1]
Gordon adds: “Creating a plan backed up by financial forecasts is sometimes overlooked initially, but having a plan to work towards and track your business against is vital.”
Types of financial forecasts
Forecasting revenue
Understanding future revenue is useful to a business for several reasons. If you know that revenue is likely to grow, you can make plans for investment. Or, if revenue is forecast to fall, the business can take precautionary steps, such as finding new ways to drive sales or reduce costs.
Revenue is typically forecast over 12 months, but it can be helpful to make a prediction for the next three years. Consider what may drive or hinder revenue growth, such as seasonal upticks, law changes, and any planned business activity like a product launch or new marketing plan.
It's important to review this forecast regularly. Gordon recommends having a “thorough strategy review every three or six months so you can make any adjustments to help you meet your business plan.”
Forecasting cash flow
A cash flow forecast takes the revenue forecast one step further by adding in expenses and revealing how much cash is actually available to you. This helps with the day-to-day running of a business, such as paying bills, hiring staff, and buying new equipment.
Jo Blood, managing director of Posture People, which sells ergonomic office products and workstation assessments, says her weekly cash flow forecast was critical for the first few years as she built the business.
“It meant we could easily see what money was coming in, what was going out, and also more importantly when, and if, it was going to run out. We made sensible purchasing decisions, which helped us to grow.”
She goes on to say that she was quite meticulous at entering every incoming and outgoing, which helped provide an accurate picture of how the business was doing.
In addition to the forecast, bear in mind that certain products can help business owners manage their cash flow. Bailey uses an American Express® Business Card to pay for online advertising, “meaning if we need to bump it up at busy periods, like Black Friday, we know we can raise the revenue to pay it back the next month".
Managing cash flow alongside vendor and supplier payments can be a tough balancing act, but Bailey uses Business Card payment terms to her full advantage. With an American Express® Business Gold Card, you get up to 54 days¹ to clear your Card balance, so you can keep your money in the account for longer and get more flexibility in your cash flow². Furthermore, for every £1 spent, you can earn 1 Membership Rewards® point³, which can be redeemed as statement credit – allowing you to free up cash for weekly business purchases.
Forecasting profit and loss
A profit and loss (P&L) forecast is commonly used by many businesses, as it takes into account cash flow, but also profit - especially profit margins.
For example, you might think your business is doing well because you have £10,000 in profit each month, but if you have to bring in £1 million worth of sales to get that, this equates to just a 1% profit margin. According to Gordon, a good profit margin to aim for, depending on the sector, is between 10% and 20%. There are also several types of profit that can be forecast, calculated via different kinds of accounting formulas.
At Posture People, while Blood previously focused on the cash flow forecast in the early days of her business, she is now more interested in the P&L report. “Day-to-day cash flow is still important but we know we’ve got a very strong buffer behind us,” she explains. “Each week we look at the P&L report with our whole team – so they understand the numbers as well.
"We’ve set targets for the year, and constantly look at whether we are achieving those targets.”
By tracking profitability, Blood quickly saw that business customer sales were more profitable. “So, we moved away from a retail unit on the high street into a warehouse unit and concentrated on selling to business customers,” she adds.
How to forecast financials during uncertain times
Finance projections are based on assumptions, and when there’s uncertainty in the economy - it can make forecasting much more tricky.
While it’s impossible to prepare for every event and eventuality, you can look at scenarios and sensitivities. What would happen if costs increased by 5%, 10% or 20%, for example? Work with colleagues to ensure you plan for a wide range of potential economic eventualities.
Blood says forecasting was critical during the Covid pandemic as revenue fell by 90% for three months post-lockdown. She was able to use her forecasts to make tough decisions that ultimately helped to preserve her business. She has also been carefully monitoring the profitability of different parts of the business to ensure it can absorb increased manufacturing costs caused by current economic factors.
1. The maximum payment period on purchases is 54 calendar days and is obtained only if you spend on the first day of the new statement period and repay the balance in full on the due date.
2. If you'd prefer a Card with no annual fee, rewards, or other features, an alternative option is available – the Business Basic Card.
3. Membership Rewards points are earned on every full £1 spent and charged, per transaction. Terms and conditions apply.
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