The first 1000 days are crucial – with many startups not making it past the three year milestone – many because of a lack of proper planning. One of the most useful tools that can help take uncertainty out of planning for your business’ future, and which many rookie startup founders often try to sidestep, is financial forecasting.
Forecasts help a business identify imminent revenue and expenditure trends so they can manage finances more efficiently into the future.
Phumlani Nkontwana, programme manager of Enterprise Development Academy (EDA) at GIBS Business School (Gordon Institute of Business Science), says financial forecasting is an attempt to predict how changes in the micro (company) and macro environment (market, industry, legislative, etc.) will affect revenue, cost levers and ultimately the bottom line in the next financial year or season.
“The trick is seeing your business truthfully and strategically,” he says.
Forecasting is an exercise that all business owners should conduct every financial year or financial season, says Nkontwana, provided they have real data at hand.
It is, however, critical that business owners extract meaningful value from all that information, says Nkontwana.
“My advice is for entrepreneurs to stay away from generic templates that undermine the data. Get real data. If you do not have data, then do objective market research. If you can’t do market research, my advice is to buy data or hire an expert to do it for you.”
For businesses looking for investors, financial forecasting can help give investors a detailed look into your financial outlook and expectations for the business, he adds.
Nkontwana says that investors look for key underlying assumptions and quality of data that back up your forecast, and if those are sound, prudent and realistic, there is a likelihood there might see your forecast as achievable.
It all starts with what growth you want to achieve for the business
If you are looking to put together a forecast for your business, Nkontwana shares with SME South Africa an easy-to-follow, step-by-step breakdown of how to create a solid financial forecast.
Step 1 – Determine the size of the pie
Get real industry and market data to understand what growth is feasible for your business. Start by understanding the size of the pie, who owns it and what piece is potentially available for you to bite.
Step 2 – Use the past to predict the future
Use revenue (sales) achieved the previous year or two as a base from which to forecast.
Step 3 – Go big or go bust
Determine your financial goals for your business. It all starts with what growth you want to achieve for the business.
With regards to whether you should be aggressive or conservative in your growth predictions for your business, Nkontwana says it’s the data and your key assumptions that will guide you.
The rule of thumb is to be conservative but if you have a disruptive new technology you own that will make your business do things better, quicker and/or cheaper or you are charting untapped viable markets, why shouldn’t you be aggressive?
Whether you are conservative or aggressive, is really dependent on the quality of the data and assumptions that back your forecast. Investors may deem you conservative if your forecast misses or understates key data that is likely to drive sales upwards, to name but one scenario. And vice-versa.
Step 4 – Load up on data
Get some more data! Are there industry/market studies providing any insight regarding the profile, changing patterns, buying trends, supply-side issues, etc. The more data you get the better.
Remember financial forecasting is ultimately an exercise to predict changes to your bottom line
Step 5 – Know your environment
Understand your macro-environment. Will there be legislation, incentive schemes and/or any other public sector-led initiatives to influence demand and/or supply decisions. If you ignore this data you might over/under state your revenues making your financial forecast inaccurate. For example, there might be government programmes incentivising new entrants, which will directly affect your forecast.
Step 6 – The bottom-line
Will your cost structure be changing downwards or upwards? If there will be changes it will affect your bottom line. Remember financial forecasting is ultimately an exercise to predict changes to your bottom line. You can’t only look at sales when you forecast, you take the comprehensive look at all your cost levers.
Step 7 – Lost and found
Did you have “lost/missed sales” (lost sales are selling opportunities that have been lost due to reasons such as an item being out of stock, that caused you to lose the opportunity to sell) in your preceding financial year? If so, add these in your financial forecast.
