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The lack of planning and control of cash resources is the reason often given for the failure of many small businesses in Australia. However, good forecasting can help reduce your business risk.
Much like a map helps you plan a long road trip, a financial forecast (often called a cash budget, cash flow, or financial plan) helps you achieve your goals and get your business to where you want it to be.
A financial forecast is a tool that allows you to use your resources where they're most needed, so you can control the cash flow of your business, instead of it controlling you. It allows you to control your money so you are more likely to achieve your desired net profit.
A financial forecast is simply a financial plan or budget for your business. It is an estimate of two essential future financial outcomes for a business – your projected income and expenses. Create a cashflow forecast by adding income and expenses as they are due. You will then know exactly how much you need to make every month for a profitable business.
A financial forecast is the best guess of what will happen to your business financially over a period of time. Usually, financial forecasts are an estimate of future income and expenses for a business over the next year and are used to develop the projections of profit and loss statements, balance sheets and, most critically, the cash flow forecast.
Predicting the financial future of your business is not easy, especially if you are starting a business and do not have a trading history. Initially, your financial forecasts will be inexact and inaccurate. However, frequent forecasting with adjustments as required will promote more accurate forecasting.
The financial forecast is critical to your business plan, especially if it is for the purpose of getting a bank loan. More importantly, you are an investor in your own business and you must have confidence in the validity of your business concept. Use a financial forecast to prove to yourself that your business will generate your desired profit and when it will start to make that profit.
A financial forecast is a vital tool in the financial management of your business and, like your business plan, requires regular review and amendment to be effective. Once the period for which you prepared the budget is over, be sure to compare the actual results against your budget forecasts. Examine why variations have occurred, take any remedial action necessary to correct the problem, or plan for them accordingly in your next budget.
Advantages of an effective financial forecast:
How often you forecast will depend on the circumstances of your business and where it is positioned in the business life cycle. If you are planning to start a business, you will develop an annual financial forecast as part of your feasibility study to prove that the business is viable.
Monthly or weekly forecasts may be necessary when the business is just starting or if the business is experiencing difficulties or rapid growth. Frequent forecasts allow you to closely monitor your figures and develop strategies to rectify any problems before they become a major issue. Rolling monthly or quarterly forecasts may be more appropriate for a stable, mature business.
You should regularly measure and monitor the performance of your business, and compare your financial forecasts with the actual figures as they become available. If necessary, adjust your forecasts to reflect the changes.
Monitoring the differences between your forecasts and the actual figures will help you to:
Creating a financial forecast shows you the financial requirements to start the business, convince you and your bank of the viability of your business or your business growth, and what resources you need to keep the business profitable.
Your financial forecast will be based on information gathered from industry and market research. Since you will be responsible for achieving the predetermined financial objectives, make sure your estimates and assumptions are realistic. Be consistent and make sure that your financial forecast reflects the rest of the business plan. For example, your sales forecast should reflect the capacity of production equipment mentioned in the operational section.
Combine the components of your financial forecasts to generate projected financial statements, (balance sheet, profit and loss statement). You may need help from your accountant to assemble the figures in the conventional format, but the research and operational assumptions should be your own.
You can develop your own financial forecast by using the spreadsheets to complete the individual components. Then add the timing dimension (when you expect to receive payment and the amount) over 12 months to generate an annual cash flow forecast.
Use the components listed below to develop a cash flow forecast for your own small business.