Financial forecasting isn’t just a task that you do or you don’t.
It’s a skill.
Like any skill, you learn and practise it over time. It’s possible to do badly. It’s possible to do well. You can get better at it.
With any skill you want to improve at, you have to put the time into it. It’s worth putting this time in because it’s an essential tool for steering your business in the right direction and avoiding the rocks.
If you don’t plan for the future, you might be blissfully unaware of the disaster you’re heading for.
To help you steer the ship, we present to you 18 actionable forecasting tips from the Brixx Team!
#1 Begin with a diagram not a spreadsheet
Before you even start playing with any figures, you should grab a pen and paper and draw out the structure of your business.
Illustrate the activities your business does, how they relate to each other and how they can be grouped together. This is a key step before you dive into creating financial reports for your business.
Financial statements are often broken down into different categories. A poor financial statement will have categories that aren’t easily recognisable as your business. They might be generic accounting categories useful for ordering figures but not great for judging performance and making decisions.
Your diagram should give you a great visual breakdown of the regions, outlets, costs centres, channels etc. that you operate. These could be further subdivided into other categories like sales lines and cost types.
This map of your business will help you create a set of reports with categories that reflect this. It’ll make your reports recognisably your business which will be far easier to work with.
#2 Start with the known
When it comes to entering figures, there are parts of your business that will be very reliable and predictable. Many regular costs will be the same amount at the same time each month. List these out first and begin adding them to your forecast.
You might have some reliable income sources too, enter those next before you move onto the areas of the business that are less predictable or more volatile.
Starting with the reliable sources of cash in or out is a useful exercise in itself. You’ll be able to look at all these predictable items in isolation without being muddied by the less accurate areas of your forecast.
You might want to save this as a separate plan to keep for reference before moving onto the other areas.
#3 Don’t go crazy with the detail
Breaking down your products into different lines will help you judge their individual performance but how far do you go? Some companies sell 3 products, some sell 3000.
The 3000 product business is going to need to find a way to group these up into top level categories. Having literally 3000 rows in your forecast to update will make it unwieldy and hard to maintain.
Perhaps you can find the motivation to do it the first time but returning to it will be a daunting task.
In theory, the more detail you put in, the more you can get out of your forecast through analysis and tracking. In reality you’ve got to be realistic about your time.
Sacrificing some of the detail so that you can actually face returning to your forecast is a worthwhile compromise.
#4 Only extrapolate IF you’ve got a lot of historical data
Extrapolating past data is often the go-to starting point for a new forecast. Moving averages can help take the trends from your past data and project these into the future.
Extrapolation only really works for very stable businesses with a long track record. The business model is well understood and executed. The market isn’t particularly volatile. Even brand new projects happen in a predictable way every year (think new iPhone releases!).
A business in this situation can work with extrapolated data and, with a few adjustments, use it reliably. However, even in these businesses it has to be used carefully. Even in the most stable company, internal business and external market factors can lead to future volatility.
Ultimately extrapolation is always dependent on the future being broadly the same as the past.
Clearly, that’s not an assumption you can rely too heavily on.
#5 Really understand your historical information. I mean really.
Rather than blindly extrapolating, the true benefit of historical information is in finding out the cause and effect that sits behind the data. What’s driving the underlying trend? Why did you get the results you did?
By really understanding the causes behind your results you’ll be able to make better predictions about whether your successes will continue into the future or not.
Will the conditions that led to success in the past continue into the future?
How might changes to those conditions positively or negatively impact your forecast?
If you can crack the reasons that drive the results, you can create more meaningful, accurate forecasts.
Top-down forecasts analyse and project your ability to capture a portion of the market your selling into. They are often ambitious and overly optimistic. They can show what you could potentially achieve but have little say in how you’ll be able to achieve it with your current resources.
A bottom-up forecast is created by looking at the individual building blocks of your business, rather than the market as a whole. How will each activity you plan on doing lead to your success?
Forecasting from the bottom upward is generally a more realistic impression of what you’ll be able to do.
By focusing on your actual resources, knowledge and bandwidth you’ll have a more grounded approach to the figures.
#7 Bring in non-financial data for the complete picture
A forecast can be made more meaningful by understanding how non-financial data has an impact on your business.
Key data such as website performance, advert campaign results or product milestones is highly relevant. The figures that end up on your cash flow forecast are often the result of these activities but they aren’t reflected on the report.
Your marketing categories record the costs, your sales categories record your income. However, there is a simple connection between the two: spending money on marketing should lead to more sales.
This can only be really understood through data external to a cash flow report. You can use this ‘behind the scenes’ data to improve your forecast going forward if you understand its impact on your cash flow categories.
This comes back to really diving into your historical data to understand the cause and effect which is so key to figuring out the mechanics behind your success.
They will also be critical for your forecast ‘assumptions’ in the next tip.
#8 Use explainable assumptions
Once you’ve moved beyond the known areas of your business and into the unknown you’ll need to base your forecast in assumptions.
If you understand the factors that drive the success of any particular category, you can make an ‘assumption’ about the future performance of those factors to drive a forecast figure.
This is where your non-financial data often comes in.
Here are some examples:
- Shopping centre footfall
- Website visitors
- Website conversion rate
- Number of phone calls per month
- Average order value
- Average customer lifetime value
- Average time to close a sale
- Average time to receiving payment
- Refund rate
These are the drivers that calculate the resulting figures in your cash flow statement.
Once you’ve worked out which assumptions drive your figures, you can use them to calculate your forecast rather than just entering a figure with no reasoning behind it.
Every forecast should have an additional document that outlines your assumptions so it’s easy for others to unpick your numbers.
#9 Test your assumptions
Since your forecast is only as good as the assumptions you’ve used, you need to test them!
This means tracking your real data against your original forecast to see where the variance is.
This is good practice anyway but in this case it will allow you to investigate which of your assumptions were inaccurate. Knowing that allows you to improve this assumption going forward and make better predictions for the future.
It’s how you move from not being able to predict an area of your business accurately to having a reliable estimate of the future.
Remember, forecasting is a learning process that improves as it becomes a habitual task.
#10 Cook the data two ways
There are often multiple ways to calculate the forecast for the same activity. Using two methods and then seeing how close the results are can help give confidence in your forecast or help identify assumptions that are wildly off.
For example, you might have top-level data on purchases across your business that gives you a number of orders per month and an average order value.
You could use this to calculate the forecast for your top-level sales line. You’d make adjustments to these assumptions based on how your future performance and activities could impact them. It’s a quick and dirty calculation, but useful too. It won’t be 100% accurate but should be in the right ballpark.
A second way of calculating the same sales line would be to map out all your product lines individually. Inspect their past data and forecast the future performance of each product in great detail.
Compare the resulting total with the quick and dirty calculation you did. Are they in the same ballpark? If not, why not?
It’s a great sanity check to ensure your numbers look sensible.
#11 Understand your seasonality
Well established businesses should have a clear view of their typical strong months vs weak months over the course of a year.
For a startup, with less data, this is more difficult. Ensure you make a prediction about which months you feel will be the strongest (and why) as part of your assumptions.
If you do have accurate seasonal data, make sure you use it! It’s critical you understand whether an increase in sales is due to genuine growth or just natural variance from market seasonality.
It comes back to understanding the drivers behind your figures.
When you can attribute the result with the cause, you can forecast more accurately in the future.
#12 Identify where the uncertainty is in your forecast
A regular criticism of the financial forecasting discipline is that uncertainty makes them inaccurate. If forecasts are inaccurate, how can you make reliable business decisions around them?
This is a strawman argument that would be valid if you really did just make one forecast at the start of the year that you blindly followed to the letter for 12 months. That would be a bad move, rightly criticised.
That’s not what the practice of good forecasting is all about though. Good forecasting is about embracing the knowledge that your forecasts are inaccurate. It’s just a question of where and by how much. When you know that, you can be prepared.
The goal is to become hyper aware of the areas that have large amounts of uncertainty (remember the earlier tip around keeping a report of your more reliable activities separate).
For example, you might identify a particular sales line that is hard to predict the results for, perhaps it’s a newly launched product. That’s fine! Just ensure you are aware of the consequences of that sales line’s performance on the business – whether good or bad.
Identifying these unknown areas now will help you be prepared in the future for whichever outcome becomes reality.
So the true purpose of a forecast is not to predict the future to 100% accuracy but to inform your present day decision making. Recognise and document the areas that are unknown and investigate the risks those unknowns can bring.
The alternative to this is not forecasting at all, which really would put your decision making down to guesswork!
#13 Explore your base, best and worst-case scenarios
The way to really explore the previous tip around embracing uncertainty is through the creation of dedicated scenarios. A best case, a worst case and a base case.
You aren’t strictly limited to these 3 variations but the general idea is to explore optimistic scenarios and pessimistic scenarios. Finally, you want to arrive at a base case that has been carefully crafted and considered to be your most realistic estimate of what may happen.
You run with your base case going forward, setting your budgets and decisions largely around this scenario. You’ll compare your actual performance against this scenario too in order to check how you’re doing against it.
However, the best case and worst case scenarios might identify risks that you factor in too. That’s their purpose, to help you prepare for less likely events so that they don’t catch you off guard.
The range of these best and worst case scenarios should still be within the realms of reality. It is unlikely that everything will go wrong to the fullest extent that they can. Looking at this scenario wouldn’t be particularly useful just because it is so far-fetched.
Looking at a bad scenario where a number of factors go wrong but not absolutely everything would be more realistic and useful.
The skill here is in judging how far you should realistically ramp up your disaster scenario by.
#14 Get a second opinion
In order to help temper your expectations and form realistic forecasts, it’s important to bring in other points of view.
One viewpoint you should seek out is from an individual you know who has a steady personality.
Someone who isn’t prone to overreactions, who can take in all the facts and assess them with a level head. In short, a realist who can check over your numbers and identify any overly optimistic or pessimistic numbers that have crept in. Someone who you know will challenge you and make you explain your reasons coherently.
If you can’t back it up, then maybe your figures need a rethink.
This is where having explainable assumptions is really useful as it allows anyone to understand how you’ve derived your figures and to question their legitimacy.
#15 Get a THIRD opinion
Seeking out another person with a pessimistic outlook will further ensure your forecast is grounded in reality.
Why a pessimist and not an optimist? Well, entrepreneurs are often incredibly optimistic characters already. They have incredible self belief and just know that they will succeed no matter what. So you should already have your optimistic viewpoint! This now needs to be tempered with someone less positive.
In addition, a forecast that is overly pessimistic or reserved is generally less of a problem than a forecast that is too optimistic.
Assuming unrealistically high revenue can lead to problems if you start spending more before you’ve proven the path you’re on.
#16 Return to your forecast frequently
In order to make the most of all the tips in this article, you’ve got to return to your forecast frequently.
A forecast is of no use if you build it at the start of the year and never return to it. Filing it away in a cabinet defeats the point. As new information comes in each month, you’ve got to return to your forecast to ensure it still makes sense.
You made decisions on that forecast, are they still valid? You can only tell if you compare reality to this forecast to see if and where it differs.
More and more companies are moving towards quarterly, monthly or even weekly rolling forecasts. This means that you keep making adjustments to your forecast with the most up to date information.
You continually evaluate your assumptions to ensure they are accurate. You adjust your expectations where the variance with reality is large. You take timely actions in your business because you are able to spot issues or opportunities early.
Ultimately, returning to your forecast and re-forecasting allows you to be proactive rather than reactive.
#17 Don’t forget about the other financial statements
Most small businesses rely on a short term cash flow forecast to get them through the next few weeks and months. However, remember this only gives you a limited view of your financial health.
The cash flow forecast is about the timing of all cash movements. It’s a critical tool to ensure you don’t run out of cash and help you pick the right time to spend and invest.
Not all cash movements have an impact on the overall profitability of your business though (for example tax or the drawdowns from a loan). Your profit & loss report gives you a truer picture of your performance and whether your business model is working or not.
On the other hand, your balance sheet statement maps out all the value in your business. It highlights all the amounts owed to the business or that the business owes. This helps you spot problems or risks and forecast the actions you’ll take to fix them. You wouldn’t be able to see these just on a cash flow statement though.
These three financial reports really work together to tell the complete financial story of your business.
Focusing too much on any one report will leave you with blind spots in your decision making.
#18 Do it, even if you don’t know how
The final tip is to get started even if you’re not exactly certain how it all works.
I opened by saying that forecasting is a skill that you can learn and improve at. Like any skill, you’ve got to start learning somewhere. Getting stuck in is the best way to start!
Don’t worry though, we’ve got a huge range of resources to help ease you into the topic of forecasting:
- A Beginner’s Guide to Forecasting Business Cash Flow for Startups
- The Ultimate Guide to Financial Forecasting & Business Projections
If you’re comfortable in the world of spreadsheets, our templates will do a tonne of the legwork for you:
Make sure you check out our jargon buster if you’re tripping up on any of the financial terminology:
Finally, if spreadsheets aren’t your thing, or you are looking for a tool with a bit more oomph you should try our very own financial forecasting software, Brixx!
It generates a detailed Cash flow, Profit & Loss and Balance Sheet statement for you (through simple inputs). But that is just the start, Brixx is a modelling tool that enables the rapid exploration of future scenarios to super power your decision making process.
Just like our blog articles, we build software that is simple and approachable ready for anyone to jump and get up to speed quickly.