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Financial Management: How to create a financial forecast for your business

Written by Latifa Yedroudj on Wednesday, 03 August 2022. Posted in Finance, Interviews

Financial forecasting is the process of estimating how a business will perform in the future – but how can we do this effectively?

Guy Rigby, Chair Entrepreneurial Services at Smith & Williamson, Andrew Harding FCMA, CGMA, Chief Executive of the Management Accounting PU at the Association of International Certified Professional Accountants, Trusha Lakhani, Business Coach at ActionCOACH, and Andrew Collis, Chief Financial Officer, MoneyPenny and Tim Vine, Head of International Finance & Risk Solutions at Dun & Bradstreet took to the stage for the second day of Elite Business on 12 March in the Financial Management panel, speaking about the importance of financial forecasting – and how to do it correctly to take your business to greater heights.

Financial forecasting allows you to measure the progress of your business by benchmarking your performance against sales and costs. What if you’re starting a new business? How can you create a financial forecast without having any data to back it? It can be tricky to estimate how much money you will need to cover your expenses in a new start-up. It’s important to analyse industry trends and market analysis, along with the consumer trends of your potential customers. You need to understand the ‘drivers’ of your business to create your first financial forecast. Andrew, CFO of MoneyPenny explained: “In terms of growing a business, that’s what you want to be doing. You want to be growing organically, and if there are acquisition opportunities then fantastic. 

“It’s understanding where the value of those acquisitions lies. Is it incremental revenue? Are there synergies that can be obtained from those acquisitions? And being accurate in forecasting those out is important. To your bank and your investors, you can articulate the value of those acquisitions from forecast perspectives. One of the challenges there is when you’re buying a business, it's new to you. It’s not knowing that business before. So, it's about getting underneath the skin and understanding those drivers is really important and often more difficult when it comes to communicating with the vendors of that business.”

What is the difference between creating a financial forecast and creating a business plan? The two are very different. A business plan does not involve the financial aspect of your company, but rather, a deeper analysis of your strategy and direction of the overall business. Meanwhile, a financial forecast is a breakdown of your estimated expenses, costs, income and profit margins. Trusha, Business Coach at ActionCOACH, explained: “When you’re forecasting and especially when you’re new, you’ve never possibly created a business plan. A business plan isn’t always a financial plan, it’s why you’re doing it, and what your competitors are doing. And then what you want to be doing, what makes you different? And what numbers you can realistically put in with the time you’ve got, and the knowledge skills you have. 

“So, creating your financial plan based on your business plan, it doesn’t have to be massive. It can be one page when you’re starting, or if you’re a really small business. And it's about catching four or five key numbers. As a start-up or someone who hasn’t been in a business a long time, you don’t always know your numbers. So, it’s about catching the key numbers you feel you can reach, and then looking back and reviewing that regularly. Because business owners sometimes make a plan, put it in a drawer, and get on with their day. Make sure you review your plan and change it with what you’ve learned. A huge bit about starting up is the learning process. So, it’s about getting your goals and putting your plan together.”

Now that we know what a financial forecast is, how can we create an accurate one? Financial forecasts are more often than not, ‘overly optimistic’, Guy Rigby, Chair Entrepreneurial Services at Smith & Williamson said. Financial forecasts are predictions of where your business is headed in, based on past performance and other factors. As your business grows, you’ll have more data to work with, allowing you to create more accurate financial forecasts and better anticipate the future of your company. Guy said: “Financial forecasts are always overly optimistic, and doing a financial forecast is a bit like a good wine. It improves with age. As the years go by and you run your business, you get to know what the norms are, and what the parameters are. 

“In the first year you’ll put down your forecast and they’ll be completely wrong because you have no idea what you’re doing. In the second year, you’ll be a bit better. And in the third year, you’ll be even better than that. My view is that you need lots and lots of headroom in a business. You need to know you’ve got access to cash. If you’re going to start trying to grow a business fast, you need to know there’s finance in the background somewhere. Otherwise, you’re taking massive risks.”

There is still much uncertainty ahead for businesses. With the Russian-Ukraine war, the rising cost of living, Brexit and the spill over effect from the pandemic, many firms are struggling to make financial predictions. How can businesses cope with the storms that lie ahead? Hope for the best but prepare for the worst, says Andrew Harding FCMA, CGMA, who works as the Chief Executive of the Management Accounting PU at the Association of International Certified Professional Accountants. He said: “No it hasn’t but we kind of knew we were going into this environment pre-pandemic. I sat down with my team and we said the end of 2019, corporate resilience was going to be our theme. And I, none of us were anticipating the pandemic, that’s a risk which wasn’t on anyone’s register. Unless they had a 20-year-old register or were worried about bird flu. 

“What we’ve seen since then is we’ve got supply chains, we’ve got inflation, and we’ve got what’s going on in Ukraine. I’m talking to Chinese CFOs and they’re saying that supply chains are as bad today after 10 days of that war as they were in mid-April 2020. And it’s happened that quickly. If you’re worried about supply chains, forget the pandemic. The war that’s going on at the moment is doing much more damage. That resilience thing, headroom, however, you want to describe it, hope for the best and prepare for the worst. It’s a pretty good maxim.”

Late payments have a huge impact on the cash flow of small businesses. Your financial forecast should take into consideration unexpected factors that could affect your income, and make effective decisions to plan for ‘rainy day’ scenarios that could happen with your business. Tim Vine, Head of International Finance & Risk Solutions at Dun & Bradstreet, said: “We’re seeing an increase in pressure on cash flow from late payments, particularly for small businesses. We surveyed a couple thousand small businesses 18 months ago during the pandemic... The average amounts of late payment debt small businesses carried were over £130,000. And that’s money they expect to collect, and it’s later than they would have planned. And I think the point around preparing for the rainy-day scenario is absolutely key. A forecast can’t be wrong because it’s looking into the future at the point that it’s written, but it can be incomplete. 

“And I think incorporating the potential of something bad happening within the forecast is critical to avoid running away with the excitement of the top line number, without realising there is bottom line cash flow. I think the late payment pressure on SMEs was exacerbated during the pandemic and will continue to increase. There are various measures in place to try to counteract the prompt payment code, but I would reinforce the importance of planning for the rainy day scenario and not being too optimistic.”

About the Author

Latifa Yedroudj

Latifa Yedroudj

Latifa Yedroudj has joined the Elite team to fully immerse herself in the business side of journalism, a strong passion of hers cultivated from young having co-run her mother's start up business since she was 18. Her interests lie in a wide range of subjects, including start ups, business, travel, and anything entrepreneurial she can get her hands on. She has worked for some of the biggest names in journalism including The Guardian and The Mirror. Follow her on @latifayed on Twitter for her latest journo rants.

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