Financial forecasts are built in part on best guesses. Planners and analysts combine recent and historical business performance, with seasonal and business cycle trends to predict financial performance scenarios that help leaders make strategic decisions. Such as whether to expand into new markets or spend on major marketing campaigns.
This challenge compounds during economic uncertainty. Underlying assumptions about the stability of the macroeconomy or the buying power of suppliers can be unreliable.
Nevertheless, your business needs to plan for the future. To adjust your forecasts to better reflect periods of uncertainty, consider reweighing your variables, expanding the cases you plan for, and collaborating with members across your organisation to get the clearest possible picture.
Elements of a Financial Forecast
When building financial forecasts, start by looking at your past business data and trends to anticipate how your position will change for financial metrics like cash flow, expenses, profits, assets and liabilities.
“A forecast basically incorporates budgeted plus actual results of an organisation to provide a direction of where the company is going,” says Kirsha Campbell, president of The Boutique Accounting. “When used correctly, it is very useful for being able to change strategy and implement innovative decisions.” The standard elements for a financial forecast include the following…
1. A Forward-Looking Time Horizon
A 12-month horizon is common, but you may need to look multiple years in the future to help with large financial decisions, like business investments.
2. Historical Data
“Most businesses employ some variant of autoregressive forecasting, which means the forecast is based primarily on historic trends,” says Bryce Bowman, founder of People 1st Advisors. “For instance, if sales have historically grown by 5% each year, then a true autoregressive forecast would result in 5% forecast growth for the next year.”
3. Industry Context
You should also consider your industry as a whole. What’s the total possible market? Do you have a competitive edge versus the industry? “Be aware of the environment your business operates in. What are the factors that affect your business, your buyers and your suppliers?” says Campbell.
4. A Reflection of Your Strategic Choices
The model should also reflect your upcoming business decisions. Will you be more aggressive with investments? Cutting costs? Trying to improve margins? These changes should be part of your model assumptions.
The Challenge with Uncertainty
While those elements work well in normal conditions, economic uncertainty over the last year has presented a new set of challenges. “[2020] resulted in unexpected shifts in consumer demand, which made it nearly impossible to use historic data to forecast sales,” says Bowman.
While the economy has begun to recover, Bowman still warns that business owners should anticipate other economic swings. It’s also hard to forecast far into the future, 12 months and beyond, given all these possible dramatic changes ahead. As a result, business owners need to rethink their approach for forecasting.
Ways to Adjust Your Forecast
Create Multiple Scenarios
One way to increase your chances of being right is to make multiple forecasts: one optimistic, one neutral and one cautious for your predictions. That way you can start thinking how your business would react to each one, versus predicting one scenario and scrambling when it doesn’t happen.
Review the Latest Data and Trends
Past market data and trends may no longer apply. Track the ongoing results for your own business and update your forecasts as necessary. For example, you could see how much your sales have changed this year and use that growth rate for your model, versus historical trends. You should also watch industry news to see how market trends have changed.
Update More Frequently
“The days of 12-month fiscal plans are over,” says Ben Richmond, a representative from accounting software company Xero. He recommends checking your results and updating your forecasts monthly and even weekly to see what way the numbers are trending. “You should have your positive scenario and your doomsday scenario and constantly be asking yourself: Which one am I tracking towards?”
Prioritise the Most Important Metrics
Given that forecasting is more challenging than ever, you may want to simplify your forecasts by concentrating on the areas that are most important to your short-term success. Is it sales? Lowering capital expenditure to free up cash? Improving profit margins? Aim to make these forecasts as accurate as possible even if it means less time analysing others.
An Effective System for the Future
While the business landscape has been challenging, this won’t be the only time you need to deal with tough modelling conditions. “A financial forecast is always lined with uncertainty. After all, business and economic environments are never free from change and unknown circumstances,” says Campbell.
Understanding how to manage uncertain conditions will help your business forecasting today as well as in the future. With an American Express® Business Gold Card, you have up to 54 days to clear your Card balance, so you can monitor how you're tracking against your forecast before committing to further spend.¹
You also get total visibility and control of your business’s spend. Up to 99 of your employees can have their own Cards while you control spending and limits from one central Account.
- 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. If you'd prefer a Card with no annual fee, rewards or other features, an alternative option is available – the Business Basic Card. If you'd prefer a Card with no annual fee, rewards or other features, an alternative option is available – the Business Basic Card.