What Makes A Good Financial Forecast?

Introduction

Apparently, 25% of businesses raising investment are trying to do so without having prepared a financial forecast. That is complete madness!

If a pitch deck sets out your vision, your financial forecast shows you have a clear plan to make that vision a reality. If you can’t demonstrate growth in numbers, then investors will not be interested. Simple!

Financial forecasting has always been important for businesses trying to raise investment but now, with the UK Business Angels Association reporting a 25% decrease in equity deals from 2022 to 2023, it is even more important to make sure you are well prepared. A good financial forecast demonstrates the plan for growth, provides transparency on your approach and so builds trust with potential investors by demonstrating you have a detailed and realistic plan for growth.

In this blog post, our friends at Focused For Business, explain in detail the key components of a financial forecast and its benefits.

What should a good Financial Forecast look like?

Let's start with what financial forecasting actually is. It’s the process of estimating a company's future financial performance based on historical data, market conditions, and assumptions about future conditions. Typically, you will need to forecast over 3 or 5 years, depending on how quickly you can get to profit.If you don’t have historic data to inform you forecasting then it’s a good idea to see if you can access some benchmark data by asking other business (ideally in the same sector) about how they grew their business.

The key sheets required in a financial forecast include:

Profit & Loss (Income Sheet): This outlines revenues, costs, and expenses to show net profit over time. It helps in understanding the profitability of the business and identifying trends in revenue and expenses.

Balance Sheet: This provides a snapshot of a company's assets, liabilities, and equity at a specific point in time. It is essential for assessing the financial health and stability of the business.

Cash Flow Statement: This shows the inflow and outflow of cash, ensuring the business has enough liquidity to operate. It helps in managing cash flow effectively and avoiding crises where the money runs out.

Financial forecasting is vital for planning and decision-making, helping businesses allocate resources efficiently and prepare for future growth. A well-prepared forecast can provide insights into potential challenges and opportunities, enabling proactive management and strategic planning.

What do you Need to Consider when Building a Good Financial Forecast

So, what makes “the bread and butter” of a good financial forecast?

1. Using Historical Data: Historical data forms the foundation of any financial forecast. Utilise data from accounting software, marketing, and product analytics tools to build a robust base for your projections. Historical data provides a factual basis for forecasting, reducing the likelihood of overly optimistic or pessimistic projections.

2. Market Analysis: Conduct a thorough market analysis to understand the size and growth potential of your market. Show evidence of market growth and future predictions. Reliable sources such as Trends, Statista, and Forrester can provide valuable market data. Interpret this data to identify trends, opportunities, and potential threats in your market.

3. Drivers of Growth: Focus on the key drivers of growth in your business. These could include the number of customers, average customer order/contract size, and frequency of purchases. Instead of relying on arbitrary month-on-month percentage increases, identify and model the specific factors that drive your business's growth.

4. Assumptions: Clearly explain the assumptions underpinning your financial forecast. Assumptions are critical as they justify how you arrived at your numbers. Ensure your assumptions are realistic and reasonable, based on market research and historical data. Transparency in assumptions builds credibility with investors.

5. Key Variables and Metrics: Highlight key variables such as sales, expenses, and growth rates. Additionally, focus on important metrics like gross profit margin, net income, Lifetime Value (LTV), Customer Acquisition Cost (CAC), and churn rate. These metrics provide a comprehensive view of your business's financial health and performance.

Getting started

Creating a financial forecast involves several steps:

1. Data Collection: Gather all necessary data, ensuring its accuracy. Accurate data is the cornerstone of a reliable forecast. Collect data from various sources, including financial records, market research reports and internal business metrics (or benchmark data if you are not yet trading).

2. Data Input: Input the collected data into a spreadsheet and connect the sheets to provide an overview in a Profit & Loss statement, balance sheet, and cash flow statement. If spreadsheets are not your strong suit, consider using templates from advisors like Focused For Business, which offers a forecast template as part of their Funding Accelerator programme.

3. Analysis: Analyse the data to identify trends and patterns. Look for seasonal trends, growth patterns, and any anomalies that need to be addressed. Understanding these trends will help in making more accurate projections.

4. Projection: Project future financial performance based on historical data and market conditions. Use the insights gained from your analysis to create realistic and achievable financial goals. This step involves estimating future sales, expenses, and cash flows.

5. Explain Assumptions: Clearly state any key assumptions and provide explanations. For example, if you assume a certain growth rate in customer acquisition, explain the basis of this assumption, such as market research or past performance.

6. Review and Adjust: Regularly review the forecast and adjust it as needed. Market conditions and business circumstances can change, so it’s important to update your forecast to reflect these changes. Regular reviews ensure that your forecast remains relevant and accurate.

7. Tools and Software: Utilise popular financial forecasting tools like Forecast or manual alternatives like Excel/Google Sheets templates. Getting the help and support of a Fractional CFO is also a viable option if you need expert guidance. Our friends at Focused For Business have a number of mentors who specialise in forecasting who support businesses on their Funding Accelerator programme. Using the right tools and professionals can provide additional insights and help streamline the forecasting process.

Common Challenges

Creating a financial forecast comes with its own set of challenges:

1. Inexperience or Lack of Forecasting Skills: Not everyone is comfortable with numbers or working with spreadsheets. Using forecasting tools and templates can help make forecasting easier if numbers are not your strong point.

2. Missing/Inaccurate Data: Track metrics as soon as possible to avoid gaps. Inaccurate or incomplete data can lead to faulty forecasts. Implement robust data collection and management practices to ensure data integrity.

3. Changing Market Conditions: Update forecasts regularly to reflect changing market conditions. The business environment is dynamic, and staying updated with market trends and conditions is crucial for accurate forecasting.

4. Complexity: Avoid overly complex models; be clear and straightforward with assumptions. While detailed forecasts are valuable, overly complex models can be difficult to manage and understand. Focus on clarity and simplicity without sacrificing accuracy.

Best Practices

To create an effective financial forecast, consider the following best practices:

1. Update Regularly: Keep your forecast up-to-date to reflect current business conditions and market trends. Regular updates ensure that your forecast remains relevant and useful for decision-making.

2. Create Different Scenarios: Develop multiple scenarios, such as best case, worst case, and most likely. Scenario planning helps in preparing for various possible outcomes and enables better risk management.

3. Engage Stakeholders: Involve key stakeholders in the forecasting process. This includes team members, advisors, and investors. Collaborative forecasting ensures that all perspectives are considered and increases buy-in from stakeholders.

4. Learn from Past Forecasts: Review past forecasts to identify areas for improvement. Learning from past mistakes and successes helps in refining your forecasting process and improving accuracy over time.

5. Present High-Level Summaries: Use visuals to present high-level summaries and provide detailed supporting documents. Visuals make it easier to communicate complex financial information and ensure that key points are understood by all stakeholders.

Reaping the Rewards of a Strong Financial Forecast

A good financial forecast is grounded in accurate data, reflects market realities, and includes clear assumptions. It should be regularly updated and not seen as just a “one off” exercise. Following these guidelines will get you started in creating a compelling financial forecast that will impress investors, but the real win is when you start to use your financial forecast as a key operational resource, letting your forecast guide your business towards success.

If you need help building a strong financial forecast, the Funding Accelerator programme from Focused For Business provides a financial forecast template and one-to-one support from expert financial forecast mentors to help you build a forecast suitable for investors.

A good place to find out more is at one of Focused For Business’s free Funding Strategy Workshops.