To understand how important forecasting is to business planning, all you have to do is look at the long list of companies that have gone belly-up as the latest economic downturn began eating away at their profits.
Your financial statements capture how your company did over a certain period (that’s what your income statement is about), where your finances stand (that’s your balance sheet), and what happens along the way (your cash-flow statement). But what tells you where your business is headed? That’s where forecasting comes in.
Financial forecasts are built around three financial statements: the income statement, balance sheet, and cash-flow statement. Even the most cautious forecasts may not be enough to anticipate big-time unexpected trouble, such as the credit crunch that left many businesses without a way to borrow. But the lesson from the latest economic troubles is clear: It’s wise to prepare for unexpected problems that may lie ahead.
Your financial forecast includes your best guesses about the future based on a set of assumptions about what you expect to happen down the road. You base your forecasting entries on what you see in your financial future.
Then, using your projections, you develop a master budget summarizing your plans for sales, cost of goods sold, operating expenses, capital expenditures, and cash-flow projections that guide your allocation of anticipated resources toward investments and expenditures that are most likely to help your business succeed.
Carefully consider every business assumption that goes into your financial forecast. Make sure you know what each one is based on. For example:
If you’re assuming that the economy will grow at a given rate, state the growth rate on which your plan is based.
If you believe that you can raise the cash you need from at least three different funding sources, be specific.
If you’re almost certain that a new technology is going to completely change the way your industry does business, explain your reasoning.
If you think competition will increase in a certain segment of your market, say so.
Your financial forecast just happens to be one of the most important — and fragile — parts of your business plan. Be able and willing to change it when the business circumstances around you change.