Many business owners do not know or understand the financial numbers of their business. This lack of understanding is one of the major reasons that businesses fail because this lack of understanding makes it impossible for a business to adjust or correct course when necessary to ensure a strong business for the long-term. One way a business owner can gain an understanding of their business is through financial forecasting. The process of forecasting forces you to understand the key drivers of your business sales and expenses and thus your cash flow. Here are some simple steps that can help you forecast the financial health of your business:
- Create a best, expected and worst case scenario for your sales forecast. This ensures that you have an understanding of what could happen to your business if a major customer went to a competitor or there is a major drop in customer conversions. By forecasting these different scenarios, you can brainstorm with your management team ways to offset the lost sales before something unexpected occurs. In other words, forecasting helps prepare you for the economic swings and the unexpected in your business.
- Forecast not only your sales and expenses but also your cash flow. Remember cash is king. A business can have “paper profits” but no cash. Paper profits could mean that the business sold on account but have not been paid yet in cash for the services or products provided to its customers. A business needs cash to pay its bills, especially start-ups that have limited or no credit history to obtain business credit.
- Use your prior year sales as your baseline. With this information you can increase or decrease sales figures by month based on one-offs and other known information that occurred historically or that is likely to occur in the near future. If as a start-up there is no history to use as a baseline, then create assumptions for sales and expenses based on information from similar companies or similar divisions of companies.
- Adjust your plan for seasonality. If your business is sensitive to holidays such as Christmas or other factors, plan accordingly.
- Review your forecast monthly and adjust accordingly. Use the forecast as an active management tool to improve the financial performance of the business. The forecast, once completed, should not be sitting on a shelf collecting dust.
- Forecast to succeed not to fail. This means do something if your sales are falling below plan. For example, if you are selling only 500 widgets versus the 1,000 planned find out why and immediately adjust your strategy and marketing to increase sales. Don’t just cross your fingers and hope for the best.
Other information to use when creating your forecast is trend information. Keep in mind the following for 2012:
- 1.9% increase in office rents nationally according to National Association of Realtors. It may be higher or lower in your local market. For 2013 it is expected to rise by 2.4%.
- 4.6% increase in travel costs including airfare, hotels and car rentals according to the National Business Travel Association
- 7 - 8% increase in employer’s share of health care expenses for employees according to Aon Hewitt Associates
- 3% increase in employee salaries according to the Conference Board
As a part-time CFO, I believe by incorporating these tips you will be well on your way of planning for 2012 and beyond to ensure a healthy and vibrant company.
