My family takes a lot of road trips and we always use Apple Maps to route us. I often use Apple Maps to navigate to places I already know how to get to, as well. Why? Because it lets me track my estimated arrival time, suggests alternative routes when delays are spotted along the way, and alerts me to accidents, traffic cameras, and speed checks up ahead.
Financial forecasting can do the same thing for business owners and leaders as they grow and scale – it adds insights (information, logic, and analysis) to your instincts (experiences and emotions).
Vision is where you’re going. Strategy is how you’re going to get there. Activity is actually getting there. Forecasting is a step between strategy and activity to map out your route. And once you get going, forecasting allows you to monitor your progress and re-routes or alerts you along the way.
But most business owners aren’t using financial forecasting. The most common reasons for this are because they think:
- They can’t forecast future results because their business is too unique or unpredictable.
- Forecasting is only for big companies with financial analysists or a full-time a CFO.
- It’s a waste of time because nothing ever goes as planned anyway.
“All models are wrong, but some are useful.” – George E. P. Box
Financial forecasts are based on guesses or assumptions. No one can perfectly predict what will happen – but that’s not the point. The purpose of forecasting is to predict what will happen in the future based on assumptions. This allows you to pencil out your plans before you take action. It also helps you to measure your progress and determine if course corrections are needed along the way.
Here are two simple ways you can start incorporating forecasting into your business:
- Predict your profits using a Forecasted Profit & Loss (P&L). Do you ever wonder whether you’re on track to hit your budget? Things don’t usually go as planned, but that doesn’t mean the original plan is worthless. It just needs updated. The Forecasted P&L is a tool to predict where you’ll end up. It’s like the “ETA” in the Apple Map.
When you created your budget, you made assumptions, or guesses, about what would happen. As you go throughout each month, you have actual results to measure your progress. The next step is to update your original assumptions based on what has actually happened and any new information you now have. You don’t need to change your original budget; the forecast is an additional tool for your monthly reporting kit.
The baseline for your forecast is your actual results (i.e. Year-to-date P&L) plus your budget for the remaining months of the year. Next, apply any new or updated assumptions to that baseline to calculate your Forecasted P&L. You’ll have a stronger prediction of where you’ll end up, and more clarity around what actions you need to take to get there.
- Calculate your revenue target using a Total Revenue Calculator. Do you realize how much new revenue you need to add to hit your revenue budget? It seems simple – increase X% over the prior year. But what decreases can you expect due to non-recurring revenue and attrition? How much can you increase your prices? It’s worth the effort to build out some additional assumptions.
First, establish your baseline (i.e. prior year revenue). Then, apply your assumptions to that baseline to calculate your budgeted total revenue. This includes estimating the:
- Amount of prior year revenue that is non-recurring, such as one-time projects.
- Percentage of prior year revenue that will be lost due to attrition.
- Increases to your standard rates/prices.
- New revenue you will add (or back into this amount by setting a total revenue target)
You can download our free Total Revenue Calculator tool to see an example and calculate your own. I created this simple tool a few years ago when I became responsible for our firm’s revenue target. It totally opened my eyes. As you’ll see in the example, a goal to “increase revenue by 25%” could require new revenue of over 50%! That’s a big difference, but once you’re aware of it, you can revise your assumptions, revise your goals, or revise your strategy.
As your business grows and scales, forecasting the future becomes increasingly important. The stakes get higher as there are more people and moving parts involved. You need insights to support your instincts. Forecasting gives you those insights so you can test your strategies, monitor your progress, and make course corrections along the way.