There’s a big difference between having a vision for the future and accurately predicting it. Entrepreneurs often have grand ideas for their company, but those dreams aren’t likely to be realized without solid forecasts to guide their decision-making. Many startups complain that forecasting takes up valuable time that could be spent selling or innovating. What they don’t realize is forecasting can actually save time and money in the long run by anticipating issues and opportunities before they arise. Once entrepreneurs master the art of forecasting, they’re ready to make smart budgeting decisions to be prepared for any situation.
Principles of Business Forecasting
Forecasting is a crucial tool for any business’s long-term success, and entrepreneurs should keep a few basic concepts in mind before they begin. These principles apply to businesses of every size and shape, so it’s wise to keep them in mind as your company grows.
- Forecasts are usually wrong – Nobody can predict the future with 100% accuracy, the key is getting as close to reality as you can with your estimates. That’s why all your forecasts should include an estimate of error to get a sense of the range of potential outcomes beyond your predictions.
- Data, Data, Data – A forecast is only as good as the data used to make it. Your research needs will change depending on the purpose of your forecast and the time period it encompasses. Entrepreneurs have extra work in this regard as they don’t have many years of their own company’s past performance data. Historical data should be combined with information about competitors and other external factors to get as accurate a forecast as possible.
- Time significantly impacts accuracy – The further out your forecast tries to predict, the less accurate it will be. Forecasts for a month out are far more accurate and thus more useful than forecasts for a full year. There’s still plenty of value in generating longer forecasts, such as seeing big-picture strategy played out over time. For specific budgeting advice or other operational concerns, use shorter forecasts.
How to Craft your Business Forecast
Before you begin building a forecast for your business, consider the purpose and audience of the forecast. Will you primarily use this forecast for your own internal strategy, or will this forecast be shown to banks and investors? Lenders will want very specific information about how you plan to fund your operations, and your engineering department likely won’t. Once you know what your forecast is for, keep these next few steps in mind as you build your predictions.
Start with your Expenses
The first step in crafting a business forecast is to total up your expenses. Entrepreneurs will need to make some assumptions about their costs, and there are a few rules of thumb that will help reach a realistic estimate. For example, marketing and advertising costs often get out of hand so it’s good practice to double your initial estimates. You should triple estimates for legal, insurance, and licensing fees which can quickly get out of hand if you’re inexperienced.
Finally, keep track of time spent on customer service. Entrepreneurs often forget to plan for this as they handle many customer service responsibilities themselves. Once you’ve totaled up all your fixed and variable costs, prepare for the research stage.
Collect Relevant Data
If you’re a new business, it’s impossible to forecast the company’s future performance without external data. Your forecasts should be built off of the highest-quality research about your industry that you can find. Data on external factors like the industry’s history, market trends, economic conditions, and competitors are most important. Then, add in any internal factors you know about, like timelines for marketing campaigns, new products, etc. Generally, the more quality data you provide, the more precise your forecast will be.
Get the Right Help
Entrepreneurs wear many hats, and early on they will likely handle most of their forecasting themselves. In a growing company, it’s unlikely business owners will always have time to properly forecast. Hiring a fractional CFO can save business owners tons of time and money that they would’ve spent hiring and training an in-house finance team. Regardless of the size of your business, forecasting is an important financial planning tool that cannot be ignored.
Conservative or Optimistic Approach? Both!
Entrepreneurs should get in the habit of producing two different forecasts when they sit down to plan for their business. One forecast should make very conservative assumptions about performance, while the other plays out a best-case scenario. This helps business owners further visualize the range of what’s possible for their company.
Dreaming of the heights their business can reach is crucial for entrepreneurs to stay motivated and inspire their team, but having restrictions also forces them to recognize potential threats faster. Both forecasts should be realistic, justified by the data, and consistent with market trends and consumer behavior.
Regulate and Revise
Regulating forecasts is the process of comparing your predictions to reality. Once the time-period in your forecast has passed, you should compare the real data you gathered to the predictions you made and look out for errors or areas of improvement. There are many factors to consider when creating a forecast and missing one can greatly impact your results.
Identify the elements that had big impacts and work them into your forecasting models. Carefully review important metrics like gross margin and operating profit margin, as aggressive models often don’t pay enough attention to costs. Over time, your forecasting models will become more accurate as you continue to collect data, but only if you put as much effort into regulating forecasts as you do building them.
Stephanie Rogers is a freelance writer for CFOshare, a provider in outsourced finance and accounting services. CFOshare’s team of experts handle your finance and accounting needs at a fraction of the cost of a full-time employee.