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Small Business Financial Forecasting: You Need It, and Here’s Why
Small Business Financial Forecasting: You Need It, and Here’s Why
Running a small business is difficult and unpredictable. Business owners often feel like they’re flying blind, reacting to problems and issues that seem impossible to foresee. Believe it or not, your friends in the financial sector may have the answer. Financial forecasting can provide clarity, predictability, and structure in managing your business. But what is financial forecasting, and what can it do to improve your business?
Keep reading to learn what forecasting is, its pros and cons, and why it’s important for the future of your business.
What Is Small Business Financial Forecasting?
Financial forecasting is a data-driven prediction of the trajectory of your business and/or industry based on historical patterns and current trends. While forecasting has historically been used more often in large companies, small businesses are utilizing this method at an increasing rate to more successfully manage their operations.
As a small business owner, taking the time to create a financial forecast ensures you are better prepared to handle any obstacles that may arise and often allows you to see them coming.
There are many forecasting methods, and you’ll need to decide what works best for your specific organization or industry (again, your friends in the financial sector can help you there).
Pros and Cons of Small Business Financial Forecasting
As with anything, there are both pros and cons to creating and using a financial forecast. While we will discuss both for purposes of full disclosure, we hope it’s clear that we consider the pros to greatly outweigh the cons in this instance, and we think you will too.
Pros
1. Assistance with Future Growth
Being able to ascertain the right timing in which to grow your business and how to manage that growth, is crucial for any small business owner—and forecasting can help with that. By analyzing past and current data, you’ll have a better idea of potential fluctuations in the market (or just your general business flow) and know when it’s time to double down on expansion and when it’s better to simply maintain the status quo.
For example, a well-prepared and analyzed forecast can predict when it’s time to hire a seasonal employee or expand your inventory due to periods of higher demand throughout the year. The ability to foresee these (often seasonal) fluctuations in the market, as opposed to just reacting to them, will result in higher profits, which you can then invest back into your business.
2. Preparation for Periods of Difficulty
A financial forecast can offer many red flags and warning signs for your business operations, but potentially the most valuable are focused around cash flow. Cash flow forecasts exist almost exclusively to ensure that businesses do not run out of capital. Keeping a consistently updated cash flow forecast will warn you of periods of potential tight cash flow long before they actually occur, allowing you to pivot business operations as necessary to avoid a business owner’s worst nightmare—running out of cash.
Financial forecasting can also help with efficient inventory management, personnel management, and even project management during projected periods of slow or retracted growth. Having these opportunities to make decisions ahead of time can save you money—and even potentially save your business.
3. Improved Business Decisions
As you create and then continually update and refine your forecasts, you’ll start to notice a pattern emerging in how you run your business. Whether it’s mistakes you’ve made as a business owner or specific industry problems and threats, having a record of past mistakes and successes is valuable.
By collecting and exploring this information, and discovering what works and what doesn’t, you’ll start to make better business decisions over time. As an added bonus, your financial forecasts will also become more accurate and more useful for future decision-making. It’s a cycle of wins!
4. Increased Investor Confidence
If your organization is at the point where you’re looking for investors, or even if you are already investor-financed, having developed financial forecasts can be a powerful and persuasive tool. Forecasts will show the effort you’re putting into making the best possible decisions for your future success, and a solid budget-to-actual report will illustrate how past projections have guided your decisions as a business owner and operator. Structure, particularly financially mature structure, is a very attractive trait when courting investors.
Cons
1. Dependence on History
Because forecasts are predictions, they generally use preexisting information as their foundation. Because history rarely presents us with a complete picture of the future, this can sometimes affect the usefulness of a forecast—especially early in a company’s lifespan. For this reason, it is often wise to use forecasts more as a method for providing general direction, as opposed to a crystal ball for your business.
2. Limited Accuracy
Similar to the point made above, it’s important to note that forecasts are almost never perfectly accurate. Whether it’s due to incorrect inputs, truly unexpected turns in the market, or simply over- or under-estimating your sales numbers, it’s crucial to remember that there is no way to reliably and consistently predict the future for your business. Thus, forecasts should be seen as a tool in your management tool belt and not the gospel by which you govern your operations.
3. Time-Consuming Process
Creating forecasts can sometimes be time-consuming, and every minute counts when you’re a small business. Forecasting requires collecting and organizing a large amount of information, analyzing that information, and then laying it out in a way that’s easy for multiple people (often with different specialties and expertise) to understand. This can be a daunting task, but, when done well, pays huge dividends.
The Importance of Financial Forecasting for Small Businesses
Despite the minor disadvantages of forecasting, small businesses often greatly benefit from the added clarity and direction it provides. As summary, forecasting for small businesses is important because of it:
- Assists in the formation of long-term goals
- Communicates goals to employees and investors
- Helps predict important upcoming circumstances
- Improves business decision-making
- Mitigates risks
- Offers valuable insights
- Allows you to consistently manage cash flow
Get High-Quality Forecasts with Ampleo
Does the idea of creating financial forecasts for your small business sound overwhelming? It doesn’t have to be with Ampleo. Our professional CFOs have extensive experience with and knowledge of financial forecasting and can work with you to make your forecasting process as useful as possible for your business.
Contact Ampleo to learn more about our Fractional CFO services.
Lauren Farnsworth is a CFO and transaction advisor whose expertise spans financial and strategic planning, cash management, forecasting and modeling, investor relations, and technical accounting. She spent five years in EY's financial services audit practice and three years as a Director of Accounting and Financial Reporting at American Express before becoming Corporate Controller and then CFO of Fieldstone Homes.
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