Welcome back to Forecasting Fundamentals – the series on all the burning questions around financial forecasting.
In this edition of Forecasting Fundamentals – we’ll tackle a common question we get asked…
Are financial forecasts accurate?
This question isn’t quite so straightforward, there isn’t really a yes or no answer.
Let’s break it down and explain why.
Short term forecasts MUST be accurate.
Last time, we spoke about the length of your forecasts, and that is a big factor in whether your forecasts are going to be accurate or not.
If you’re doing a short term forecast (up to about 13 weeks) then your goal is to be as accurate as possible.
It’s absolutely key to understand when cash is going in and out of your business. Getting payments out by even a day could send you into the red, so paying close attention to payment dates and terms is essential.
But even then, beyond a few weeks worth you can’t predict with any degree of certainly what’s coming in the future.
You might have payments due to you within 30 days, and you might assume that 90% of them will be paid within 30 days, but as soon as you start having to assume anything, you are into the world of prediction.
You can, and should, strive to make your forecasts reflect reality as strongly as possible – so that they will be better tools for helping you make decisions about the future. But as soon as the assumptions begin, you lose a bit of accuracy. And this potential divergence from reality only increases the further ahead you plan.
Long term forecasts are a different story…
Longer term forecasts aren’t as accurate.
There, I said it, they aren’t accurate, BUT they’re not destined to be accurate!
A 12 month forecast can and should be accurate, but when you start going out to 2, 3, 4 or 5+ years, the accuracy does drop off.
Accuracy really isn’t the be-all end-all of forecasts though.
Anyone who creates longer term forecasts for their business will tell you that their goal isn’t about accuracy and getting the minute detail correct, it’s about testing scenarios, planning for growth and strategising.
Modelling scenarios to help you prepare for the future
So, long term forecasts aren’t as accurate, so what do they specialise in?
What long term forecasting does let you do is ask questions about the future – questions like:
- When can I hire more staff?
- When can I open a new shop?
- When and how can I reach higher revenue?
Asking these questions help you make predictions, predictions about the future of the market, your business and external forces.
It’s highly unlikely that all your predictions will come true, but if one does, you’ll be prepared!
Businesses like to make several scenarios, based on realistic predictions about what may happen – one often being ambitious, one being what is most likely and another being the worst outcome.
These are known as best, worst & base case scenarios, and are commonly asked for when approaching banks and investors for funding.
But the best businesses will be ahead of the curve and make several scenarios often.
But how often is often?
Well, this will depend somewhat on your industry, where market shifts and forces differ greatly.
A business in technology, where competition is strong and changes in the market happen at a rapid pace, might want to jump into their plans several times a month.
However, a restaurant where markets are slower to change, might only once a month.
By creating scenarios often – you can be prepared for more possibilities, meaning if and when one does come true, you’ll be prepared and have a plan in place.
A tool to help with your long term scenario planning
So all this is great in theory, but many business owners struggle to find the time to create multiple plans battling with Excel and organising the right formulae.
It’s only half the battle creating it, editing it everytime you want to create another scenario is a whole different challenge.
This is one of the main reasons why we created Brixx, to help entrepreneurs and business owners easily plan for the future of their business.
Brixx is a financial modelling tool, producing up to 10 year forecasts of your Cash Flow, Balance Sheet and Profit & Loss.
Build from components that model an existing element of your business, such as income, expenditure, assets and funding.
Then add in more components to model future activities in a modular and flexible manner that makes scenario testing intuitive and easy.
Model your business’ future, today with a free 7-day trial!