If Your Company Doesn’t Have a Financial Forecast, You’re Wasting Time and Money
Every company has goals. Where do you want your organization to be 5 years from now? 10 years?
Most even have a general idea of the benchmarks you need to hit to get there—”By increasing revenue to $15M by August 2023,” “adding x number of new products next season,” etc.
However, if your company doesn’t have a detailed financial forecast telling you how to get from one benchmark to another, then chances are you’re wasting extensive money and resources. You’re also missing out on a huge advantage for success.
Why Every Company Needs a Financial Forecast
The number one mistake most organizations make is prioritizing accurate present and historical data over analyzing and modeling future financial activities. We call this a “rear-facing” or “historically-facing” financial strategy. If the primary focus of your finance team is to have clean, accurate, up-to-date books, then you may be stuck in a “rear-facing” financial strategy.
Every company understands the importance of financial record keeping. It answers important questions about the performance of the company, including:
- What is our organization’s health to-date?
- Are we making money or losing money?
- Can we pay our financial obligations?
- Do we have good news or bad news to report to shareholders?
Having accurate and up-to-date financial records is vitally important for day-to-day operations. However, having an accurate financial forecast can define the level of company success.
A financial forecast takes the information from the historical performance of the company and compares it to market and competitive data. Trends are analyzed, then the data is used to create a month-by-month proposal defining each month’s financial activities and strategies in a best-case, worst-case, and expected-case scenarios. This essentially “turns on the headlights,” revealing the most successful path forward to achieve the company’s goals. In most cases, a financial forecast will turn into a rolling budget to define financial decisions moving forward. It is also a living document, meaning it can (and should!) be updated to account for business and market changes, opportunities, evolving goals, and more.
“Financial Forecasts Should be Kept Up-to-Date and Regularly Referenced for Budgeting and Strategy Analysis”
If you’re like most companies, then chances are you have one of the following:
- KPIs or goals related to finances that you use as guideposts for defining monthly or yearly targets
- A financial forecast (possibly written during fundraising or to qualify for a loan) that is outdated, inaccurate, or has become forgotten
The difference between a complete and accurate forecast compared to an incomplete or inaccurate one are astronomical. In a study by the Institute of Business Forecasting, they found that an improvement in accuracy of just 1% from under-forecasting or over-forecasting resulted in an savings of $970,000 – $3,520,000 per year in the companies that participated in the study.
While the study was conducted with large companies and the results will vary based on a company’s current strengths and weaknesses, the idea of a hard cost due to inefficient use of assets remains true regardless of company size. This cost can be significantly reduced through accurate financial forecasting.
3 Reasons you Need a Financial Forecast:
While most companies hope for the best, prepare for the worst, and accept whatever comes, a financial forecast allows a more predictable outline of events. A forecast is a blueprint for how to get from point a to point b. It uses historical data and educated analysis of industry and comparable competitive trends to predict, analyze, and optimize outcomes. Instead of fielding challenges and opportunities as they appear, a financial forecast turns on the headlights so you may more confidently and effectively lead your company where you want to go.
1. Financial forecasts create a clear path to achieving your goals
Former Success Magazine editor, Darren Hardy, touts the importance of having a direct, defined path from where you are to where you want to go. In his book Living Your Best Year Ever, he describes the difference between having a long-term plan and lacking a detailed forward-facing plan to crossing a field in a straight line or a wandering one.
Keeping a studied eye on your feet and the ground directly in front of you, intentionally taking step after step through the field, will produce a zigzagging and skewed path through the field. Keeping your eyes trained on a tree on the other side and taking step after deliberate step toward that tree, however, puts you on the shortest path to achieving your goals: a straight (or straighter) line.
It’s not enough to know you want to take good steps every day; you need to know exactly which steps to take to get where you want to go. Think of it like building a house. It’s not enough to know that you just “want to build a house,” or even to know exactly what you want it to look like when it’s complete. It’s not even enough to have a basic idea of the framework. Without having a clear plan for materials, labor, not to mention a design for electricity, ductwork, and plumbing, you’ll waste excessive time and money trying to coax the materials in front of you each day into the home of your dreams. You will probably also end up with a house that achieves only a fraction of the potential it could fulfill otherwise.
2. Creates trust and confidence in lenders when raising capital
Whether you have growth contingent on investors or loans, most companies at some point or another have to raise capital. They must present their company to a panel of decision-makers who will ultimately control whether or not they will provide the money for that growth.
Common misconceptions about fundraising are that financing is about the story, the relationships, or luck. In reality, it’s much simpler than that: Financiers are looking for a company that knows exactly how it’s going to succeed.
Lenders and investors see multiple plans every day. While the intrigue behind a project is what gets business owners through the door, no investor wants to write a check based on a hope and a prayer. The greatest opportunity for success is showing how you’re going to use the money from the capital raise to make the company–and investor–more money, and to show exactly how you’re going to get there.
Success isn’t an elusive mystery; it’s quite simply defining goals and figuring out exactly what has to happen to achieve those goals. After that, all you need is consistency and tenacity in taking the steps between where you are now to where you want to go.
As Darren Hardy says, “A genius can still get lost without a map. Even a blockhead will beat the genius as long as he has a map and a plan.”
3. A financial forecast tells you what resources you need (and when)
If you’ve recently had the conversation, “What (cash investment, materials, employees, inventory, sales, etc.) will it take to get x done?” then you’re on the right path for building a financial forecast. A great forecast tells you what resources you need, when you need them, how you’re going to pay for them (if relevant), and the resulting financial implications of these resources.
One of the major factors of inefficiency within a company is failure to know exactly what resources are needed at any given time. Whether the resource in question is cash funding (how much do you need to make sure you don’t run out before your next funding round?), personnel (how many employees do you need to prevent overstaffing or understaffing to achieve this quarter’s goals?), or materials, your company will benefit a great deal with a clear idea of the “hows” and “whens.”
Financial Forecast Tip: Be Flexible. Planning the future is different from predicting it
Intelligent forecasting is the closest you will get to a crystal ball, but no forecast is plug-and-play. Even though your forecast intelligently details how to achieve your goals, the greater the degrees of inaccuracy, the greater your wasted resources and inefficiency. Forecasts are meant to be a living document. An experienced CFO will use the forecast to guide a monthly and yearly budget, then regularly compare actuals to forecast to ensure your goals are on track.
How to Create a Financial Forecast
Many small businesses lack an accurate forecast (or a forecast at all) simply because a forecast can be difficult to put together. It begins with clean, accurate, and complete books, then combines it with educated assumptions, industry trends, competitive activities, and more.
In most cases, a financial forecast is best developed by a professional CFO with experience in this level of modeling and strategy. Many companies may lack an in-house CFO with the tools or knowledge to create a financial forecast and to keep the forecast accurate and updated. However, by utilizing an outsourced CFO, businesses regardless of their existing financial team can experience the massive positive impact of a financial forecast.
What is the state of your financial forecast? Schedule a free, no-obligation consultation with one of our CFOs.
This article was originally published in 2018 and was updated in December, 2022.
About the Author
Tom Barrett is a skilled CFO with extensive experience. His financial expertise is key to helping companies with strategic financial planning, data analysis, risk assessment, budgeting, forecasting, cash flow management, and much more.
You may also be interested in...
Understanding Industry Rivalry
Michael Porter, a well-known strategy professor at Harvard identified five forces that shape the profit-making potential of the average firm in the industry. The five forces are: rivalry, buyer power, supplier power, threat of new entrants, and the threat of...
5 Lessons from The Big Short
In 2010, financial journalist Michael Lewis published a book telling the story of investors who made money in the 2007-2010 crash by betting against the mortgages we now know were doomed. He called it The Big Short: Inside the Doomsday Machine. On 11 December 2015,...
3 Ways to Think Like a Consultant
Consultants are third-party resources companies can use to fix problems within their organizations in all kinds of areas. Some specialize in advising on general strategy problems, while others focus on technology, marketing, finance, operations, or human resources....
Life Hacks from Clayton Christensen
In the business that so many of us are caught up in on a day to day basis, it’s difficult to regularly take a step back and remind ourselves what matters most and why we do everything that we do. Clayton Christensen insightfully discusses this need in his book How...
Choosing a Retirement Plan that Attracts Talent
Choosing a retirement plan for your small business can be intimidating, requiring you to choose an IRS structure, an administrating recordkeeper, and investment options. Step 1 Choosing an IRS structure is the first step, and you likely already have one selected. If...
Making Money Part 4: Cash Flow Statements
This is the fourth of four articles on Making Money. Making Money Part One: Don’t Let Work Get in the Way argued that ‘Cost of Goods Sold’ activities should come first. Making Money Part Two: Net Profit described ways use income statements to make more money. Making...
5 (Legal) Tax Shelters, by Forbes’ William Baldwin
William Baldwin outlines 401(K), 529, Municipal Bonds, Master limited partnerships, and The Loss Harvest. Click Here --> 5 (Legal) Tax Shelters, by Forbes' William Baldwin
Making Money Part 3: Balance Sheets
This is the third of four articles on Making Money. Making Money Part One: Don’t Let Work Get in the Way argued that ‘Cost of Goods Sold’ activities should come first. Making Money Part Two: Net Profit described ways to use income statements to make more money....
Energy Management is the New Time Management
Time management is a good way to gain control of your activities. Energy management is even better. Both types of management attempt to build self-control. Measuring time allows us to measure ourselves, and that’s an essential activity. In the words of Peter Drucker,...
3 Easy Steps to Evaluate Your Pricing Strategy
A friend of mine was once asked in a job interview to develop a value of a particular chair in the room. My friend proceeded to use different financial valuation techniques, including sum of parts, trying to account for the price of the materials used to make it....
Making Money Part 2
This is the second of four articles on Making Money. Making Money Part One: Don’t Let Work Get in the Way argued that ‘Cost of Goods Sold’ activities should come first. This article will explore how you can use your income statement to make more money. The following...
Brand Valuations & Building Brand Value
Finance and marketing don’t always play well together, but sometimes they’re inseparable. One of those inseparable moments is brand valuation - assigning a dollar value to the identity of a company, business unit, or product line. Placing a dollar amount on a brand is...
