Importance of financial forecasting

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One of the main reasons for a small business failure is lack of planning of cash. A good forecasting mechanism increases business success chance and minimizes the failure risk. Small business owners must realize the importance of this tool to plan ahead in order to make their business successful.

A successful business owner relies on a forecast to develop a business strategy. In this global competitive environment, a business must adjust its strategy constantly. One way to address this competition is that owners/managers must predict what will happen tomorrow. Businesses who accurately forecast, advance ahead, while the ones that don’t, fall behind.

Budgeting is an essential part of a financial forecast; it is a mechanism to estimate future income and expense by utilizing and manipulating few variables. Different methods can be used to determine future income and expense. Predicting the future is not easy, which is why business owners sometimes seek professional help to prepare pro forma financial statements. These sets of statements are the financial plans for small business owners.

Why it is critical?

Financial forecasting is an important tool if you are applying for a business loan. It also plays a vital role if your business is cyclical, so you can overcome cash shortfalls and plan ahead accordingly to pay your vendors, rents, payroll and other business expenses.

If you are planning to introduce a new product, it allows you to construct a model of how your business might perform financially if certain strategies, events and plans are carried out.

How often should you prepare a financial forecast?

It depends on the circumstances of your business. Small businesses should prepare a financial plan quarterly or semi-annually. If you are having cash-flow issues, then preparing a financial forecast more often would be a better strategy. Likewise, if you are experiencing rapid growth, more frequent forecast strategy allows you to measure your performance more effectively and develop a plan to rectify any issues which could be critical in making your growth strategies successful.

Should you prepare a forecast yourself?

According to Morton J. Marcus, director of Indiana University’s Business Research Center, which provides forecasting services, “Most financial executives still rely on implicit forecasts they construct for themselves, using information they have gathered from a number of sources and working on an instinctive basis. But it is unlikely that they are looking at all of the variables. Using professional forecasts is really nothing more than prudent business behavior.” One of the reasons to hire an outsider is objectivity; there will be no emotions attached, whereas, an owner/executive might construct a forecast based on the assumptions with which he/she has some sentimental values.

For example, one of my clients had a dream to open up a restaurant so badly that he ignored all the warning signs. After discussing the idea with him and after introducing other cost factors which he disregarded, we found that the plan was not viable at that point and had to be revisited in future with a different location. As Marcus said, “models are based on past behavior. As conditions and behavior change, models must be revisited and modified”, with the help of a professional.

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Nafees Chaudhry

Nafees Chaudhry is the founder of CNC. Providing accounting, tax, and consulting services to small businesses and individuals for 23+ years.

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