Financial forecasting is partly an art and partly a science. The goal is–obviously–to be as accurate as possible as these numbers tend to guide key decisions, advise budgets, and to plan for and project growth. It also establishes trust and confidence in many key financier relationships.
There are three keys to an accurate and effective financial forecast:
1 – Collect and analyze as much data as possible
The more you analyze your company’s historical data and industry data, the more information you’ll have to find averages, trends, and anomalies that will help you more accurately write your forecast.
Look for correlations, trends, and profitability ratios.
As you analyze your data, it will help to constantly ask “Why?” Why did sales go up while marketing costs stayed the same? Why did variable costs jump by 5% when sales only jumped by 4%? Use the answers to these questions to form educated guesses for how certain patterns may (or may not) continue in the future.
Once you’ve done internal analysis, it is also important to compare it to what is known about industry. Is your company growing on pace with the industry, or are you growing faster/slower? Understanding how your company compares to industry averages gives you more can provide clarification, guidance, and trend information in your financial forecast.
2 – Determine & implement key metrics
Metrics organizations use are often different between industries and company size, but some common metrics that may help guide a financial forecast include:
- Average revenue per customer
- Customer acquisition cost
- Cost per unit sold
- Employees per customer
- Average wages
These metrics are important in making more accurate projections. If average revenue per customer is $100, then you can forecast that for every 10 new customers your acquire, your revenues will increase by $1,000. Based on that prediction, you can make decisions like hiring new employees, investing in operational capital, and buying advertising.
It is important to remember that detail is your friend here; more detail means more accuracy. It is also important to do a quick sanity check to make sure your numbers are justified. Are you forecasting 25% growth while the projected industry growth is 2%? Are you projecting personnel expenses to stay flat despite adding 200 new customers? Forecasts are a combination of numbers, patterns, and logic.
3 – Debrief your forecast
Once your quarter or year is over, go back to your forecast and compare what actually happened. Look for areas where the your existing numbers vary from what you had predicted. Again, ask “Why?”
Debriefing previous forecasts will help you improve your forecasting methods. Improving your forecasting methods will help you plan for the future, adapt your business, and make profitable decisions.
Financial forecasts can be overwhelming and time consuming, but they’re well worth the effort. They are a roadmap that can help take you from where you are to where you want to go with less wasted time and money than moving forward without a plan.
For assistance, advice, or tips for your financial forecast, feel free to contact us to talk with a CFO today.
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