Why Financial Forecasting Is Important

Do you reject financial forecasting because it is going to be wrong or it is too hard to do? Do you think it takes an MBA or CPA to do right? Don’t. Let me show you, with this post, how much you have to gain with simple and practical forecasting that anybody can do.

To be clear, this post isn’t about how to forecast. For that, I’ve included useful links below. This one is about why to forecast.

The real goal

The goal of business forecasting is not what you might think. It isn’t about accurately guessing the future. It’s about running your business right. With good forecasting you track your business numbers back to the drivers that you need to manage. You watch the connections between sales, costs and expenses. You watch the ups and downs. If sales are up, you adjust inventory. If sales are down, you adjust expenses.

For a real-world example, I use my company in 2008 after the great recession kicked our sales in the gut. Our forecast was way off. We were down 20 percent from what we expected. So, the forecast wasn’t accurate but seeing that the real results were so much lower than the plan helped us move quickly into expenses to see what to cut.

It’s a lot like having a dashboard. With forecasting, you see the connections between the different uses and sources of cash. You compare what you expected to what happened—and you make changes.

It doesn’t take pinpoint accuracy. It takes good educated guesses.

Keys to Success

First, do it yourself. You can do this. You know your business better than anybody. I have an MBA and I can do weighted averages, smoothing and econometric models. But I don’t. I was a vice president in a market research firm and I saw that the best forecast was not the technical or mathematical models but the common sense and judgment of the business owners.

Second, look for the drivers. For example, in a business that sells over the Internet, drivers are likely to include web traffic, meaning people looking at the website. That is likely to include browsers who got there by organic search, by clicking ads on the web, by clicking links in social media or some other way. Aside from traffic, there’s also conversion rate as in how many of the people browsing on the website purchase something. As another example, in a business selling physical goods in stores there are the numbers of stores stocked, the sales per store per month and returns. And yet another example, for the all-important forecast of cash flow, watch for drivers such as inventory not moving, bills paid and invoices out to customers waiting for you to get the money.

Third, break your forecast into factors you can track and manage. Think of the difference between tracking just sales in dollars compared to tracking sales in units and average price per unit. The latter gives you better information to manage. Break it into factors you can track.

A critical factor

To get the management benefit of forecasting, you have to spend a minimum of time tracking results and comparing them to the past and to the forecast.

The active phrase is “plan vs. actual analysis.” Accountants and financial analysts call that “variance analysis.” It means looking at your forecast and comparing that to the actual results so you can note the difference and make changes.

Good management is frequent course corrections. It’s a fact of life. Even on a straight super highway, steering requires lots of small movements. And business owners know well that we are not on straight super highways. Our path includes a lot of hills and valleys, starts and stops and turns.

The benefits

So you forecast your key business indicators including sales, costs, expenses and cash flow. And every month, you review results and compare what happened to what you expected to happen. Ideally, you compare it as well to the previous month, quarter and year.

You don’t just look at the numbers. You look at the business behind the numbers. You identify what to do more of, what to do less of and what to change.

And that, in the end, means better management.

Tim Berry is the founder and chairman of Palo Alto Software and bplans.com.  He is the author of business plan software Business Plan Pro and www.liveplan.com. His books include his latest ‘Lean Business Planning’ from Motivational Press. Contents of that book are available for web browsing free at leanplan.com. Tim can be found on Twitter as Timberry and he blogs at timberry.bplans.com.

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Meadowlands Magazine

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