7 Tips to Demystify Financial Forecasting and Strengthen Your Business

What is financial forecasting?

What would you do if over half of your business's revenue was delayed? Run out of cash? Panic? Or strategically shift to your backup plan and carry on? With good financial forecasting, you could be prepared for the reality that 61% of invoices are being paid late this year.

Financial forecasts help business owners anticipate and plan for the future. If you don't have one yet, don't sweat it: Many businesses don't. After all, nobody seeks entrepreneurship because they love paperwork. But, a financial forecast is a surprisingly simple tool that can help you survive shocks to your business and thrive. 

You’ll find many free financial forecast templates online. Before putting pen to paper though (or numbers into cells, more likely), understanding these seven principles can help you approach financial forecasting with confidence.

Financial forecasting tips to consider

1. Understand who (and what) your forecast is for

There are two general audiences for your financial forecast: People outside your organization and people inside of it.

Externally, you're creating it for lenders, investors, mentors, business partners and even potential buyers who will want to make sure you have a deep understanding of your business so they can decide whether to invest or not.

Financial forecasting also serves as a guide for you, and others within the company, to set goals for growth, spending accountability and benchmarks. In addition, it helps you anticipate cash flow needs so you can plan ahead. Over time, the data in these documents can provide insights that allow you to play to your strengths — and know where to course correct.

2. Don't get bogged down in precision

It's great to be detail-oriented, but one thing that can confuse business owners during the forecasting process is overcomplicating their forecast. Start off with very general buckets for your revenue and expenses. The dollar amounts in each category should be whole numbers preferably with zeros — think $100, $1,000 or $10,000.

As your business and forecasts evolve, you can become more precise because you'll have those previous forecast iterations to rely on.

3. Financial forecasts aren't one-and-done

Speaking of forecast iterations: Your first forecast should be far from your last. Financial forecasting is a routine. Even if you're the sole employee, incorporate a monthly review-revise process with yourself.

Each progressive forecast will make you more mindful of your goals, accomplishments and how you're spending your time. You'll also be able to square your forecast to your actual numbers so that, over time, your forecast can become more accurate — and powerful.

4. Treat business forecasts and household budgets differently

Another common forecasting mistake is thinking about your business forecast like a household budget — it's actually very different. Because most people have a regular paycheck, their budgeting process starts and ends with controlling their expenses to fit within their set income.

With a business forecast, both revenue and expenses are controllable. Business owners should start by thinking about their revenue, not their expenses. While there are certainly revenue factors outside of your control, like market forces, competition and loss of demand, you also have tools to control revenue, such as sales, special events and new product or service offerings.

5. Consider your revenue drivers first

Heather Tuason, founder of , Arena, a CFO consulting firm, explained how she approaches the forecasting process in a recent conversation with the Nasdaq Entrepreneurial Center. She breaks revenue forecasting down into four dimensions:

• Start with prior performance. This is pretty much the only part of your financial forecast you know for certain.
• Next, add in your ambitions, which are your growth projections for the mid- and long-term future.
• Include headwinds, which are forces that affect your business. Think interest rates, cash flow needs or a market slowdown.
• Finally, add in industry benchmarks. How much growth are similar businesses experiencing? Tap into your network, and you may be surprised by how generous your peers are in opening their books.

6. Project expenses with revenue in mind

When forecasting expenses, consider their nuanced relationship with revenue:

• To fatten your profit margins, your expenses can't grow at the same rate as your profits.
• Returns on different expenses show up at different times. Today's marketing costs, for example, may not turn into revenue until next month — or next quarter.
• Employees are huge expenses — and potential revenue drivers. So they require savvy scrutiny. How much revenue is each employee generating? Can you re-train an underperformer in another role? Will you need seasonal help soon?
• Price out your ambitions. What will they cost?

7. Time to kick the tires on your forecast

This is why you've made a financial forecast — to learn from it and plan around it. Get feedback from peers or mentors on your financial forecast and make adjustments based on your learning and new financial numbers as they come in.

Some questions you can start asking are: What does your forecast tell you about upcoming cash flow needs? What about payroll demands? Are there holes you need to fill with new revenue? Is it time to vet new vendors to lower expenses? These questions are exponentially easier to answer when you have a clear financial forecast in front of you.