In this week’s edition of Forecasting Fundamentals, we’re going to cover the advantages of financial forecasting and why is the best thing on earth.
Ok, might be slightly overexaggerating there, it’s not the best thing on earth, but it is one of the best tools you can use for planning your business.
There’s absolutely loads of advantages of financial forecasting, but to ensure this article isn’t 10,000 words long, I’ve picked out 4 of the most important ones below.
Be sure to read the other articles in our fundamentals series:
- What is Financial Forecasting?
- How Long Should a Financial Forecast Be?
- Are Financial Forecasts Accurate?
- Financial Forecasting Methods | Top-Down vs Bottom-Up
- Do I Need a Budget or a Forecast? | Budget vs Forecast
- What’s the right tool for creating a financial model?
- How to create a financial model
- Financial Planning And Analysis (FP&A) | A Brief Overview
Explore more than one potential future
When we talk about “potential future” we’re going on about the possible paths that your business takes over the course of the next few months and years.
Even if you’re focussed on your day-to-day operations, a long term strategic plan isn’t something to shy away from, it helps your business achieve its goals in the future. If you don’t have one eye on your goals, you could end up working against them, or underperforming compared to what you could achieve.
A good forecast gives you a platform to test out different scenarios and explore different opportunities, for example, the impact of hiring more staff, launching a new product etc.
So the best way to explore the potential futures of your business is to forecast!
Understand how your business works
You might think you know how your business works, but what we mean here is asking yourself:
“What drives the business forwards, what works, what doesn’t work?”
Being able to look at your financial model and understand what drives growth within your business allows you to do more of the good and less of the bad.
Keeping costs low is important for any business, but to understand the long term consequences of cutting back, or investing in infrastructure or people, is something that a longer term financial forecast is uniquely suited for.
The way to achieve this is to list out every cost, every stream of income, every asset and every liability that makes up the business in a model that can be easily understood, drilled into and asked questions of. It sounds tough, but think of it as drawing your business on a piece of paper, including all the elements. Good financial modelling software will then take these disparate inputs and spin them into a web of meaning that’s easy to grasp.
The long and short of it is that you just cannot fully understand how your business works financially without a living, breathing financial model.
Stress test your business
Stress testing is an important element of planning your business’ future.
Ever wondered if you can survive a period of downtime? Or what if sales take off, can you meet that demand? Is your business susceptible to seasonality?
Stress testing your business can answer these questions.
But what do we mean by stress testing?
When you have built a financial forecast (more on how to actually do that here) you can model out different scenarios. For example, you might want to model seasonality in your business by making sales 20% lower or higher over some months.
Stress testing in a tool like Brixx makes doing this easy and interesting – simply add in a new business activity with a click of a button and then adjust, toggle on or off as necessary to test out different assumptions.
Validate your business model
Choosing your business model (how your business actually goes about making money) is something that’s often glossed over in business planning.
It’s so vitally important because a business model is your path to being profitable.
Some models just won’t be suited to your business, for example “low-cost” is a business model many businesses go for, but can often end up being a race to the bottom of the barrel, pricing yourself out of business.
This is why it’s critical you get it right – without a financial forecast, you won’t truly know whether your business model is going to work until it is too late.
So how can you be sure that your business model works?
Forecasts can help you verify your business model, showing you what will work over the long term, in line with your assumptions about customers and costs.
One of the strengths of forecasting is you can try business models out before risking it in the real world.
You can simulate the results of different business models in an afternoon! Rather than using one for a year, only to find out it’s not suitable, wasting time and money in the process.
And there you have it, a concise list of our top advantages of forecasting.
This list is not exhaustive, there’s many more advantages to financial forecasting that I could list, but we’d be here a while.
The common theme across all these advantages is just how flexible financial models/forecasts are, they allow you to test out ideas quickly and plan your future effectively.
Doing this in spreadsheets can be a challenge – which is why we created Brixx.
Brixx helps you stress test and model your business’s future with ease. See what all the fuss is about with a free no-obligation trial.