This is a guest post by Addition. Addition help keep you on top of your figures so that you can move your business forward. They cover all the bases so you can excel, without Excel. Here is there step-by-step guide to building your financial forecast.
If you’re reading this, it’s probably because you’re ready to take your business to the next level.
Firstly – congratulations!
Secondly, in order to scale up (whether you’re prepping for growth, or courting investors) you need to know your numbers. This is where financial forecasting comes into the picture.
What is a financial forecast and why do you need it?
Forecasting is the process of looking at past and present data – as well as marketplace trends – to predict the company’s future financial performance.
Why is it useful for your business?
Financial forecasting will show your entire business plan in numbers. It will convey what’s needed, at what cost, and what’s expected to be generated – all based on specific assumptions.
Maybe you need some upfront investment – whether it’s materials, machinery or people. You might wonder, ‘Is my business model economically viable? And how can someone who doesn’t know the business get comfortable with either joining as an employee or investing?’ The answer can be found within your forecast
Here are four ways you can use a financial forecast for leveraging growth:
- To show the potential of your business
If you’re trying to raise money or attract talent, you need to demonstrate that your business model is sustainable – and that there are benefits for becoming involved.
- To allocate funds
More often than not, founders receive investment or funding and don’t understand the nuanced points around cash flow. What about taxes? Costs? Growth? Where can your finances make the most impact?
- To set targets for your team
Knowing the numbers will help you set both financial and non-financial targets for your team. For example, if you’re setting up an ice cream business, your targets could touch on how much of each flavor you want to sell each month, or how many locations you want to set up at.
- To prepare for potential funding rounds
Building a financial forecast will give you a strong starting point from which to approach investors. Why? This leads into our next forecasting FAQ…
Why is it useful when approaching investors?
- It shows your competence
You’ve written things down, you’ve created a plan, and you know what you need to do to hit your targets. Clearly, you know your stuff.
- It shows what needs to be done to make your business work
You might have £10k in monthly running costs, and know that you need six months of development before you can start bringing in revenue. Your forecast will show how much investment you need to sustain running costs until then.
- It helps set parameters for valuation
Looking at your profits and costs will show you what your company is bringing in. So if an investor offers you £500,000 for 20% of your business, you’ll know whether it’s a good deal or not in terms of ROI.
Now we’ve established the vital role financial forecasting plays in business growth, let’s talk through how to build one. But before we get started, take a moment to determine which stage your business is at. Are you pre-revenue, or already operating? This is pretty important, as it’ll influence your approach to building your forecast.
Right – let’s get started.
Setting the groundwork to build a great financial forecast
Where to start?
Think about converting your elevator pitch into numbers. Having the following information gives you a great starting point:
- The product
What is it? What does it cost to make, and how much are you going to sell it for?
- The market
Think about how many sales you want to make in a month. How many other people are selling this same product in your area? How often are people paying for this product or service? When people do purchase, how much are they spending for this product?
- The people
Who do you need to get your product out there? Do you need an in-house team or will you outsource?
These are the building blocks of any pitch deck. With financial forecasting, it’s simply about turning these facts into numbers. Here’s how to do that.
Building your financial forecast
The essential building blocks are:
We’ve broken each of these down into subcategories for a clearer picture.
Not sure where to start? Don’t panic. We’ve got you covered.
- Start with your expenses
Let’s look at People and Related Costs, and Software and Development.
Link this to your start-up launch date. Make a list of one-off costs to get your product/service up and running (equipment, developer costs etc). Then list your regular expenses (salaries, subscriptions, licenses etc). This will answer the question ‘What’s your monthly burn rate?
- Outline your sales process
Look at your Revenue, Cost of Sales, and any Sales and Marketing Costs. This will help you arrive at your CAC:LTV ratio (customer acquisition cost to lifetime value). How much will you sell your product for? How many units will you sell? Do you know how much it’ll cost to produce your product, and how you will acquire customers? Use your sales funnel to help guide you.
- Time your money flows
Understanding when cash comes in and when it goes out comes under Working Capital.
When do you have to purchase your inputs? Do you know when your customers pay you? When are payments made to the relevant tax authorities? This will help you identify potential cash flow gaps.
- Only two things are certain in life…
So don’t forget Taxation. This includes VAT, PAYE and NI, Corporation taxes and potential R&D claims on your expenses (post year-end filings)
- Review and Reassess
Don’t just make a forecast at the beginning of the year and then ignore it for the next 12 months. Regularly evaluate how close your operating results mirror those forecasts so you can pick up any cash flow gaps – and figure out how to close them.
Key tips for forecasting
- Plan before you start
Sketch out all the key drivers to consider in your elevator pitch. You could do this in mind-map or world cloud format – whatever works for you. The important thing is to get it all on paper.
- Make an Assumptions Page
Use the data from the previous exercise and turn it into assumptions that can be used dynamically. These will drive your forecast.
- Think Monthly
Once you’ve done that, build things out on a monthly basis. Trying to blend them annually can cause a lot of headache – especially if seasonality is a factor. Stick with month-by-month data over a three year period, if you can.
- Make it Visual
Spreadsheets are functional, but can make information hard to digest. Use visuals like pie charts and bar graphs for sense checking and presentation when building your forecast.
- Include returns for shareholders
This one really cannot be stressed enough. Make sure your projections include ROI for your investors and yourself – whether immediate or in the future. This is part of demonstrating a sustainable business model. You can’t just keep injecting personal or fundraised cash into the company. It needs to be delivering returns at some point.
Hopefully, this guide has given you insights into why a financial forecast is useful, and how to start building one from scratch. If you want help getting started, be sure to download our free financial forecasting template here.
Want more support (or even one less thing to worry about)? Get in touch with Addition today. We help businesses like yours build powerful forecasts every day. Why not join the 180+ SMEs making use of our expertise and give us a call?