Forecasting for Small Business Owners: What is It? (Part 1)
When packing for a trip, you work logically, yes? If you’re going to Florida, you’ve got a bag full of shorts and sunglasses. If you’re headed to the ski lodge, you’ve got snow jackets to spare.
But do you make assumptions about what you think the weather will be? Or do you check your weather app for more detailed predictions?
Making decisions for your small business is no different from packing a suitcase. You know where you’re traveling, and you need current information to inform how you’ll prepare. But whereas savvy travelers check for weather updates, savvy small business owners should be utilizing another tool: financial forecasting.
What is forecasting?
Forecasting is the process of analyzing current and past data to predict future financial circumstances. Just like when we listen to our trusty weather person, forecasting isn’t 100% foolproof, but it does give you a pretty good estimate so that you can decide whether or not to pack that heavy rain coat or invest in that new product.
Forecasting also shifts depending on different factors like time of year, type of product, and market trends. Focusing on multiple forecasts allows your business to predict its financial future more accurately and properly distribute resources. After all, if annual holiday sales are sunny and clear skies, but September sales are lagging in the rain, you know where you need to put your protective gear.
What are the benefits of forecasting?
While it can be oodles of fun to check the weather, most of us find ourselves glued to the forecast because we’re trying to grab vital information. We want to make the smartest decisions we can based on our previous weather experiences and current circumstances.
It’s the exact same situation when it comes to your business. It’s just the questions that differ. Rather than worrying about snow days, you might find yourself asking questions like:
- Will I have room in the budget next month to afford an inventory increase?
- Am I likely to make quota for the next three months or do I need to make changes?
- Can I afford to hire more staff?
- Could I take money from next month's budget to solve an emergency this month?
- Which of these products is more likely to sell?
- How can we improve our marketing strategy?
By looking at market trends and previous financial statements, you can make smarter decisions and take steps to grow your business in record time.
Better, faster decision-making means stronger leadership, more accurate budgets, and higher revenue.
What are the types and methods of forecasting?
The first step in forecasting is deciding what you want to know. All forecasts are informative, but it doesn’t really make sense for you to check the weather in Chicago if you’re flying to Hawaii. Remember, it’s all about efficiency!
When it comes to small businesses, there are three types of forecasts and two methods of forecasting you want to be on top of:
Types of forecasts:
- Demand forecasts: Also called sales forecasts, these forecasts use your previous sales data and trends to predict how much demand you might see for certain types of products. Demand forecasts are great tools for estimating how much inventory you’ll need in a given month and how many staff members/hours you’ll need to handle it. Ideally, your demand will stay pretty steady, but we all know that when you prepare for a drizzle, you end up with a hurricane.
- Cash flow forecasts: Cash forecasts predict how much money flows in and out of your business in a given period—usually a month, quarter, or year. This forecast is not only useful for budgeting, it’s also critical when it comes to applying for Small Business Association (SBA) loans. As you’ve probably learned from tax season, nothing excites the Fed quite like the financial secrets of your business. In order to receive a loan from them, you need a documented history of cash flow. Just think of it as receipts saved for a rainy day.
- Startup cost forecasts: Contrary to popular belief, your startup expenses don’t end immediately once you open. Fully launching a business can take up to a few years, leaving you with a shockingly long financial winter. Startup cost forecasts help you navigate those blizzards. If you can regularly predict large, one-time expenses, you can better budget on a month-to-month basis and stay warm and cozy until tax season.
(On a related note, check out our blog on the Top 8 Tax Documents for Small Businesses to Track.)
- Qualitative: Qualitative forecasting doesn’t use hard-number data. Instead, it looks at market and sales trends to predict buyer behavior. This method is perfect for small businesses who are just starting out and may not have a lot of historical data to work off of. There’s no reason for only the big, established companies to hog all the tools to success.
- Quantitative: Quantitative forecasting is all about the numbers. It analyzes past sales, expenses, grosses, debts, and credits to more accurately predict specific financial outcomes. If you’ve ever dreamed of time-traveling into your business’s future, quantitative forecasting is your secret machine.
Do I need fancy software to start forecasting?
Absolutely not! Meteorologists might have an advantage when it comes to predicting the weather, but anyone can stick their finger in the air to see which way the wind is blowing. Next week, we’ll cover Part Two: How Does Forecasting Work?
No matter how accurate your forecasts may be, we all know there’s always a chance of rain. However, you can prepare for any weather with the right tools and strategies. Contact Know Your Numbers Accounting today for help predicting your business’s financial future. Whether you’re a fresh startup or a strong small business, we’re happy to lend an umbrella.
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