As a rule, entrepreneurs usually don’t like to think about financial forecasts. However, they are a necessity, no two ways about it. Not only do they attract investors, but also help in long-term strategic planning.
However, the forecasts must be accurate to be useful. Hence, below are a few ways in which one can gain more surety in financial forecasts:
1. Focus on Expenses First
As much as one tries, no company can accurately predict their sales. Plus, with discounts, vouchers, etc., sales revenue is also an elusive number. One of the few things a business can be fairly sure of is the expenses they incur within a year or so.
Thus, one should build a forecast model by first looking at the fixed costs. These include your rent, utility bills, insurance, etc. The variable costs come next, which are linked to the revenue one generates.
After the calculation of expenses, a financial forecaster should project controllable expenses. They should pinpoint where a company can slash extra costs. If the revenue is more than expected, the financial forecast should also be able to tell where to best invest the extra gains.
2. Use Multiple Forecasts
Using multiple forecasts can be difficult and mind-boggling. Everyone wants absolute accuracy and certainty. Unfortunately, this is rarely the case in business. Maintaining multiple forecasts can help a business to stay inflexible in the plans. They also make for realistic expectations for the company’s stakeholders.
Multiple forecasts also involve using multiple scenarios. There may be a prediction where one assumes that everything goes well or better than expected. Then there should be one which somewhat goes with Murphy’s Law, thinking that everything would go wrong. This would allow one to be cautious as well as optimistic. An online essay writing service, for example, should have a plan B for network crashes.
According to the scale of the business, one can have more scenarios for financial forecasts. This is also applicable where a business is in an uncertain environment. For example, a government policy change after the elections could severely impact the financial future of any company.
Even after you have taken every factor into account, see if your projections somewhat match those of your competitors. If you are operating in a niche market, this could be difficult. In such cases, comparing with your own operating and financial history might be the only choice. Nevertheless, one has to learn from what is available to them.
Seek out and compare key financial ratios. These include individual revenue for departments or product, total headcount, and gross margins. It’s very difficult for a business to significantly change any of these.
If you see a ratio improving by a large percentage, your protection is likely too optimistic. If it’s the other way round, then you need to start hoping a bit more and worrying a bit less. If your competitor does not have similar projections, you would know just where you have to make changes in your forecasting.
4. Write Down Assumptions
In forecasting, assumptions are unavoidable. However, one should manage assumptions without any personal or instinctual bias. The best way to do this is to write them out and see how they look in black and white.
Forecasting assumptions include thoughts in how the market would change, including the number and actions of competitors. Technological progress is also a considerable factor.
Careless financial forecasts can upset a company’s investors and lead to mismanagement in expenses. A business could even find itself bankrupt in such a case. Hence, it is immensely important for each businessman to strive for accurate forecasts.