Jun 15, 2020 10:48 AM EDT
Why Learning Financial Forecasting is Important for any Business Owner
What do your neighborhood mom and pop candy store and a multibillion-dollar corporation have in common? Financial forecasting. At least that is what they should have in common.
Defining Financial Forecasting
Financial forecasting is often the key to the success of a business, regardless of its size, industry, or where it is located. It can elevate that traditional candy store mentioned earlier to a global conglomerate status. If global domination is not quite your style, though, then forecasting can also help to keep your organization stable and ensure that your cash flow remains positive.
So, what exactly is financial forecasting? In its most basic sense, it refers to a prediction about business conditions that will likely affect a company, another entity, or even the entire nation. This financial forecast includes trends identified through data and analyzes how those trends can affect the monetary status of an enterprise at some point, moving forward.
In short, a financial forecast is simply a plan for your business. Financial forecasting can help both small and large companies (as well as those in-between) plan for what is to come.
It can also help new or struggling businesses plan for loans or other capital injections from outside sources. The process is an essential step in determining plans for any business.
Creating Your Financial Forecast
Although creating a forecast of your company's financial status may sound intimidating, the process is probably more straightforward than many people believe it to be. To identify the trends in external and internal historical data, you will need three statements: Cash Flow statement, your Balance Sheet, and your Profit and Loss statement.
When taken together, these three statements will show how well your business has done up to a specified point-in-time. Understanding these figures is key to understanding the changes necessary to improve the performance of your business in the future.
Financial forecasting is such an essential aspect of business planning that it may benefit prospective or current business owners to invest in an online MSA degree program to understand the ins and outs of the subject.
A master's degree in accounting will include discussions of the real importance of creating a coherent and including financial forecast. Although financial forecasting can be done without one, this type of master's degree from an accredited university will give you more significant insights into financial planning for your business. It will lead to a better knowledge of the fundamentals of managing your cash flow, projected incomes, and possible financial pitfalls.
Getting a master's degree in accounting online could be the perfect resource to further your knowledge of financial forecasting and business planning, while also giving you enough time to focus on running your business. The online option means that you have a flexible schedule where you can study and work on assignments at your own pace. If you prefer to study at night after the workday is done, then you can do so.
Planning for the Future
Here is a scenario to illustrate the importance of financial forecasting. Imagine you are running a small but popular candy store (let's continue with the same example).
Your business has been going great for the past few years. However, you learn a significant manufacturer of your best-selling candy well be shutting down in three years or so.
This event will dramatically limit the amount of candy in production and raise the price significantly. It could shape up to be a disaster for your business. This problem is precisely the type of issue that financial forecasting would be perfect for solving.
How to Use Financial Forecasting
Financial forecasting can come in two forms: A budget and a forecast. A budget is a more specifically tailored document that shows where you want your company's finances to go in the next year. Financial forecasting in the form of a budget will give you a year plan for achieving the goals you have laid out for your business.
A forecast provides you with a view of what you expect to happen based on current and historical trends. Financial forecast in the more specific "forecast" form will give metrics to measure against your plan, providing you with the most updated view on what you expect to happen in the future.
Keeping with the same example, you, as the owner and manager of a small, successful candy store, are now aware of a significant price increase for your most popular candy in three years. With a financial forecast in the more specific "forecast" format, you will be able to use your current records to determine when to raise prices on that specific candy, and by how much.
By updating the "forecast" every month, you can use your previous month's forecast to analyze and adjust your new forecast to fit your current financial situation. You can alter your plan based on the analysis.
With financial forecasting, you will be ready for more eventualities and challenges that your business may face moving forward. You can create plans that may result in a potential reduction in sales, an increase in product prices, or any other events that may adversely affect your business's performance.
By introducing these sensitivities into your forecast and planning for different scenarios, you will place your business in a great spot to recover from any hardship. In other words, you will be ready for any negative scenarios that might be coming your way.
Measuring the Metrics and Your Success
Let's revisit the candy store example one last time. It has been a few years, and because of your forecasting, you have not only survived the candy price increase, but your store has become even more popular than before. You are now looking to add a second location.
Your goal is to expand your store's reach to a different part of the city. However, your money alone will not entirely cover the cost of renting, stocking, and staffing a new store. Thus, you decide it is time to seek outside investors to help with the next financing stage.
To start the process, you have the first meeting with potential investors. They ask for "current and historical financial trends" of your business to decide if your financial status will make you a good investment.
Does this sound familiar? Because you created a forecast and have been updating it for a few years now, you have the financial records that show the trends of your business. Now you know where you have been, where you are, and where you can get to in the future.
These figures will help investors to see that you know your business, its place in the economy and that you have weathered storms. They are more likely to invest in your business because they have trust that you will take it long-term.
Your financial forecast (both your "forecast" and your budget) can also be used as your planning chart to show the direction you plan for your business in the future. Your investors are pleased with your current and past financial results, and they now have a concrete plan for your business's financial future, making them feel secure in investing in your new store.
As we can see from the example, the metrics you get from your financial forecast will more clearly define your company's financial requirements. Whether you are the new business on the block or looking to expand to different markets, capital is the most critical asset.
Fully Understanding Your Business
These forecasts will not only allow you to make the best possible financial decisions. Financial forecasting, in both forms, will ensure you are informed on the standing of your business.
You will also have a solid idea for where you would like your company to go in the next year and beyond that. If that direction is to expand, then forecasts and budgets are often required if you're looking for bank loans or investments from private lenders.
Once you begin forecasting, along with making sound business decisions, you can count on your new or existing company to continue to thrive during even the most critical hardships. By keeping your financial forecast updated appropriately (monthly for "forecast" form and yearly for "budget" form), you will have better insight into the direction your company is going.
You will know where it needs to go and be able to determine how to get the organization there. Among the key questions to ask yourself as the business owner are what decisions you need to get to that point, and, most importantly, what plan do you need to implement those decisions? Forming a cohesive plan is essential.
Conclusions on Financial Forecasting
Investing in learning about financial forecasting is investing in the financial stability and success of your company. As you are probably aware by now, financial forecasting is hugely important for your business. With a robust forecast or a blueprint for your business, you and any investor can be safe knowing there is a plan. A plan that is backed by trends and is regularly checked against itself and updated to reflect market changes is a dependable one.
Join the Conversation