A Small Business Owner's Guide to Financial Forecasting

A financial forecast is more than just a document for attracting investors or securing loans—it’s a dynamic tool that can guide your small business decisions every day. If you have a financial forecast in hand, you’re equipped with a roadmap to help you reach your goals, navigate challenges, and adapt to changes.

In this article, we’ll dive into the importance of financial forecasting, how to create a financial forecast for your business, and some practical tips to make it work throughout the year.

What is Financial Forecasting

Financial forecasting process involves predicting future revenue, expenses, and profits, which can help small business owners make informed decisions, plan for growth, and avoid financial pitfalls. Your financial team, such as Bernstein Financial Services, would generate a report that estimates your future financial performance based on historical data, industry trends, and internal goals.

The financial forecast report, also known as financial projections, allows business owners, managers and decisions makers to compare actual performance against projected performance, helping them identify areas where the business is underperforming or exceeding expectations.

Why Financial Forecasting Matters

Forecasting gives you a clearer picture of your company’s financial health, helping you make strategic decisions regarding expansion, hiring, or cutting costs.

Furthermore, the process allows small business owners to:

• Securing Financing: When lenders and investors want to see your financial projections, well-prepared forecasts can help you obtain loans or attract investment.
• Budgeting: By anticipating future revenue and expenses, you can create a realistic budget that aligns with your business goals and prevents overspending.
• Cash Flow Management: Understanding when your business is likely to experience revenue shortfalls or cash crunches allows you to plan for them in advance.

Types of Financial Forecasts

Small businesses typically focus on two main types of financial forecasts: short-term and long-term.

• Short-Term Forecasts (Monthly or Quarterly): These are used to predict performance over the coming months. They help with day-to-day management, such as planning for seasonal fluctuations in sales, managing working capital, and ensuring you have enough cash to cover immediate expenses.
• Long-Term Forecasts (1 to 5 Years): These are used to set business goals and strategies. Long-term forecasts help guide decisions about large investments, expansion, hiring plans, and major purchases.

Practical Tips for Effective Forecasting

1. Update Your Forecast Yearly: Schedule an appointment at least once a year to reflect changes in the market, your sales, or operating conditions.
2. Be Conservative with Projections: It’s easy to be overly optimistic about future growth. A conservative approach to revenue projections, paired with a realistic view of expenses, will provide a more accurate and helpful forecast.
3. Scenario Planning: Create multiple forecasts based on different scenarios, such as a best-case, worst-case, and most-likely forecast. This will help you prepare for various outcomes and make contingency plans.
4. Seek Professional Help: If you’re not confident in your ability to create accurate financial forecasts, don’t hesitate to seek help from an accountant or financial advisor. They can provide valuable insights and ensure your projections are grounded in reality.

How To Create A Financial Forecast For Your Business

A financial forecasting is a roadmap to achieving your business goals. Here's how to create a forecast that not only reflects your current position but also gives you the insights and strategies you need to drive future success.

In this post, we’ll walk you through our process for creating a customized financial forecast for your business.

Step 1: Gather And Review Your Historical Financial Data

The first step in building your financial forecast is understanding where your business currently stands. To do this, we start by gathering all available historical financial data, including Income statements (profit and loss statements), Cash flow statements, and Balance sheets.

If your business is new and lacks historical data, we rely on industry benchmarks to build a foundational understanding. This step ensures we have a solid base to work from, allowing us to forecast with accuracy and relevance.

Step 2: Define The Forecasting Period

Next, determine the timeframe for your forecast based on your needs and goals. We recommend starting with a 12-month period, because it provides actionable insights without overextending into uncertainty.

• Short-term forecasts (monthly or quarterly, up to 1 year) are helpful for managing cash flow, budgeting, and immediate decision-making.
• Long-term forecasts (1 to 5 years) support strategic planning for growth, major investments, or expansion projects.

Step 3: Establish Key Assumptions

For any forecast to be effective, it needs to be based on clear, realistic assumptions. These assumptions serve as the framework of your forecast.

• Expected revenue growth: assumptions about sales trends, market demand, and seasonal factors.
• Projected cost changes: potential increases in costs due to inflation, market conditions, or anticipated business changes.
• Pricing adjustments: If you’re planning to change your prices, estimate the impact this will have on demand and profitability.

Step 4: Estimate Revenue

Revenue estimation is where we begin to see the financial picture take shape. Using both historical data and our agreed-upon assumptions, we estimate your future revenue by:

• Analyzing past performance: We look at historical revenue data to identify growth patterns and trends.
• Segmenting revenue streams: If you offer multiple products or services, we forecast revenue for each stream individually to create a comprehensive view.
• Factoring in growth expectations: Based on our discussions and assumptions, we project potential growth month by month.

For newer businesses, lean on industry data, market research, and competitive analysis to produce an informed revenue estimate.

Step 5: Estimate Expenses

After estimating revenue, we turn our attention to your expenses. We break down these costs into two main categories:

• Fixed costs: These include rent, salaries, insurance, and other costs that remain constant regardless of sales.
• Variable costs: These expenses, like materials, commissions, and shipping, fluctuate with changes in sales volume.

We analyze historical expense patterns to establish a baseline, then layer in expected increases or decreases. This helps us create a realistic expense forecast that can adjust with your business’s growth.

Step 6: Create A Cash Flow Projection

One of the most critical aspects of any financial forecast is cash flow management. We develop a cash flow projection that will help you anticipate periods when you may need additional funds or when you’re positioned for surplus cash. Our cash flow projection includes:

• Opening balance: The cash you currently have available.
• Cash inflows: Projected revenue and other income sources.
• Cash outflows: Anticipated expenses, loan payments, and any other outgoing payments.

This forecast allows us to pinpoint months where cash flow might be tight and suggest strategies for covering gaps, such as securing a line of credit or adjusting payment terms.

Step 7: Develop Financial Statements

Now that we’ve gathered all of the necessary data, we compile it into three key financial statements that form the core of your forecast:

1. Income Statement (Profit & Loss): This outlines projected revenue, expenses, and profit over the forecast period, providing insight into overall profitability.
2. Cash Flow Statement: This shows anticipated cash inflows and outflows, highlighting periods when liquidity might need attention.
3. Balance Sheet: This provides a snapshot of your business’s projected assets, liabilities, and equity, giving you a broader view of financial health.

These statements are invaluable for financial planning and can be easily reviewed on a monthly or quarterly basis.

Step 8: Regular Review And Adjustment

A forecast is only effective if it’s kept up-to-date. As part of our service, we review your forecast regularly to compare actual performance with projections. This allows us to identify trends early, make adjustments, and keep your forecast aligned with real-world changes. Our regular reviews involve:

• Comparing actual results to forecasted figures: We analyze variances to refine future assumptions and projections.
• Updating assumptions as needed: If market conditions change or your business pivots, we revisit the assumptions to ensure they remain accurate.

We also provide scenario planning, offering you a view of best-case, worst-case, and most-likely outcomes, so you’re prepared for any situation.

How To Use Your Financial Forecast Throughout The Year

Whether it’s planning for expansion, managing cash flow, or refining your budget, your financial forecast is a powerful tool to help you achieve your business goals, one step at a time. Here’s a guide on how to make the most of your financial forecast throughout the year.

1. Set Clear Goals And Benchmarks

At the beginning of the year, use your forecast to set clear financial goals. These might include specific sales targets, profitability goals, or expense reduction efforts. Break down annual goals into quarterly or monthly benchmarks to keep them manageable and actionable. By regularly tracking your performance against these benchmarks, you’ll gain insight into how your business is progressing and be able to celebrate small wins along the way.

2. Monitor Cash Flow To Stay Ahead Of Challenges

A cash flow forecast tells you when cash inflows and outflows are likely to occur, helping you stay prepared for tight periods. Throughout the year, revisit your cash flow forecast each month to compare your actual cash position with your projections. This allows you to identify any cash shortfalls before they become a problem, giving you time to arrange financing, delay non-essential spending, or focus on collecting receivables.

3. Use It To Adjust Your Budget In Real-Time

Your financial forecast serves as a starting point for your budget, but as the year progresses, actual results may differ from your expectations. Adjust your budget quarterly based on your financial performance, especially if revenue or expenses are significantly higher or lower than projected. This helps keep your spending in check and ensures that resources are directed to areas that are driving growth.

4. Reevaluate Staffing And Resource Needs

Your forecast can also help you make smarter staffing and resourcing decisions. If your forecasted growth targets are being met, you may feel more confident about bringing on additional staff, investing in new technology, or upgrading equipment. Alternatively, if your forecast shows lower-than-expected growth, you can delay hiring plans or shift employees to more critical roles.

5. Adapt To Market Changes With Scenario Planning

Financial forecasts can be flexible tools if you use scenario planning. By creating multiple versions of your forecast—such as best-case, worst-case, and most-likely scenarios—you can stay agile and ready for various market conditions. Throughout the year, evaluate which scenario is closest to reality, and adapt your strategy as needed.

6. Inform Strategic Decisions And Investments

Your financial forecast is invaluable when it comes to big decisions, such as expanding operations, launching a new product, or entering a new market. Revisit your forecast when these opportunities arise to assess your financial capacity. By analyzing projected cash flow, profits, and growth trends, you can decide whether the timing and resources are right for these strategic moves.

7. Measure Progress With Regular Performance Reviews

Each quarter, compare actual results to your forecasted figures. Identify areas where you’re outperforming expectations or falling short, and analyze the reasons behind the variances. These regular performance reviews will help you refine your forecast over time, making it a more accurate and valuable tool for planning.

8. Prepare For Tax Season And Year-End Planning

As the end of the year approaches, your financial forecast can help you plan for taxes and close out the fiscal year smoothly. By reviewing your forecasted income and expenses, you can make tax-saving decisions, such as making business purchases, contributing to retirement plans, or deferring income. Your forecast also helps you identify any outstanding expenses, invoices, or budget adjustments you’ll need to address before year-end.

9. Refine Your Forecast For The Next Year

At the end of the year, you will meet with your financial team, such as your advisor at Bernstein Financial Services, and review how accurate the predictions were and what assumptions held true. By identifying where variances occurred, you can adjust your future assumptions and make more reliable projections moving forward.

Final Thoughts on Forecasting for Your Small Business

Using your forecast in a proactive way is like reading a roadmap that gives you confidence to make decisions that will drive long-term success. Use it to guide your small business throughout the year, helping you plan for growth, avoid financial surprises, and make data-driven decisions.