Financial forecasting for better business decisions

Effective financial forecasting can have tangible effects on the success of your business.

You should have an accurate idea of how much money your business will make in the coming months and years. Not only does this allow you to make better decisions for your business, but having realistic financial projections will help get the attention of potential investors. 

Projections and forecasting can be tricky, as you try to anticipate expenses, alongside trying to predict how quickly your business will grow. With some forethought, you can plan ahead.

What is a financial forecast?

“In its simplest form, a financial projection is a forecast of future revenues and expenses. Typically the projection will account for internal or historical data and will include a prediction of external market factors.”

There are different methods of financial forecasting, including quantitative and qualitative.

What is the purpose of a financial forecast?

The general purpose of a financial forecast is to provide predictability in the financial planning process. This can differ depending on the type of forecasting being used: accrual-based or cash-based. 

Accrual-based forecasting, records sales and expenses when transactions occur, not when cash is exchanged. This makes it ideal for accountants to monitor transactions smoothly. 

Whereas, for new businesses with limited cash, a cash-based forecast can be more advantageous. This approach highlights cash flow patterns, including the timing of payments received and invoices paid.

Since collecting receivables can take time and payables may be deferred, cash-based forecasts offer immediate insight into liquidity. As a business expands, integrating both cash flow and accrual-based forecasts can enhance accuracy and decision-making.

What is the difference between quantitative and qualitative forecasting?

A key difference between quantitative and qualitative financial forecasting is that quantitative forecasting relies on numerical data and statistical methods, while qualitative forecasting involves subjective analysis and expert judgment. Here are some forecasting examples:

Quantitative Financial Forecasting

• Uses a data-driven approach, like historical data, figures and statistical methods

• Examples include financial modelling on past statements and time series analysis

• It’s ideal for budgeting and analysing trends, due to predicting specific figures

• Businesses can benefit from it by projecting revenue, based on historic patterns

Qualitative Financial Forecasting

• A more subjective approach, using expert opinions and non-numeric factors

• Uses the Delphi method, market research, expert interviews and scenario analysis

• Ideal for businesses where politics or market sentiment could play a large role

• Often used if no historical data, or where an industry is risky or changing rapidly

We’ll explain how these types of forecasting could benefit your business later in this guide.

In general, you will need to develop both short- and mid-term financial projections. 

A short-term projection accounts for the first year of your business, normally outlined month by month. A mid-term financial projection typically accounts for the coming three years of business, outlined year by year.

What does a financial forecast consist of?

Most financial projections include three types of financial statements:

1. Income Statement

An income statement shows your revenues, expenses and profit for a particular period. If you are developing these projections prior to starting your business, this is where you will want to do the bulk of your forecasting. The key sections of an income statement are:

• Revenue – this is the money you will earn from whatever goods or services you provide.

• Expenses – be sure to account for all of the expenses you will encounter, including direct costs (i.e. materials, equipment rentals, employee wages, your salary, etc.) and general and administrative costs (i.e. accounting and legal fees, advertising, bank charges, insurance, office rent, telecommunications, etc.).

• Total income – your revenue minus your expenses before income taxes.

• Income taxes

• Net income – Your total income without taxes.

2. Cash flow projection

A cash flow projection will demonstrate to a loan officer or investor that you are a good credit risk and can pay back a loan if it’s granted. The four sections of a cash flow projection are:

• Cash revenues – this is an overview of your estimated sales for a given time period. Be sure that you only account for cash sales you will collect and not credit.

• Cash disbursements – look through your ledger and list all of the cash expenditures that you expect to pay that month.

• Reconciliation of cash revenues to cash disbursements – this one is pretty easy: you just take the amount of cash disbursements and subtract it from your total cash revenue. If you have a balance from the previous month, you’ll want to carry this amount over and add it to your cash revenue total.

• Any extra salary for business owners – if applicable, include the drawdown of a monthly salary if self-employed or in a partnership, and dividends if a limited company. This encourages you to include your standard 'monthly pay' as part of monthly expenses, as it's often overlooked. Afterall. If you “make” £20k profit as a self employed person you aren’t really making a profit, just a salary.

Note: one of the key pitfalls of forecasting your cash flow projections is being overly optimistic about your revenue.

3. Balance sheet

This overview will present a picture of your business’ net worth at a particular time. It is a summary of all your business’ financial data in three categories: assets, liabilities and equity.

• Assets – these are the tangible objects of financial value owned by your company.

• Liabilities – these are any debts your business owes to a creditor.

• Equity – the net difference between your organisation’s total liabilities minus its total assets.

Note: you will want to be sure that the information contained in the balance sheet is a summary of the information you previously presented in the income statement and cash flow projection. This is the place to triple-check your work – investors and creditors will be looking for any inconsistencies, and that can greatly impact their willingness to extend your company a line of credit.

To complete your financial forecasting, you’ll want to provide a quick overview and analysis of the included information. Think of this overview as an executive summary, providing a concise overview of the figures you’ve presented.

When you are preparing your financial projections, it’s most important to be as realistic as possible. You don’t want to over- or underestimate the revenue your business will generate. It’s a good idea to have an accountant,  trusted friend or business partner review your financial projections. Also, be sure to avail yourself of all the online resources available – it’s best to learn from people who have created projections before.

Types of quantitative financial forecasting

These methods will bring insights into your business, with an emphasis on data and figures.

Straight line

Also known as linear forecasting, this is a simple yet effective method of financial planning. It involves making predictions by assuming a constant rate of change over time.

Straight-line forecasting can particularly help small or new businesses, as it doesn’t require complex calculations. It helps businesses estimate future revenue, expenses and sales, based on what’s come before. They’re easy to present to stakeholders because of their simplicity.

Percent of sales:

This is a forecasting technique that estimates various expenses or investment levels as a percentage of a company's total sales revenue. It provides direct correlation between costs and revenue, helping your business to budget, control expenses, and assess your overall performance.

Like the linear forecasting method, it’s easy to show to stakeholders and is adaptable for various expense categories. By adjusting percentage rates, you can explore scenarios too.

Moving average:

This is useful for identifying trends and reducing the impact of noise in data, the moving average method is ideal for making short and mid-term predictions for your business growth.

It works by calculating the average of a specific number of past data points to predict future trends, effectively smoothing out fluctuations. It’s a simple method and works particularly well when you’re dealing with inaccuracies or volatile data, just don’t miss anything important.

Simple linear regression

This statistical method models the relationship between two variables: a dependent variable (what you're trying to predict) and an independent variable (used to make predictions).

It’s used for determining how changes in one variable affect another, such as predicting sales based on advertising spending. This can make it a valuable tool in economics, finance and social sciences, as it provides insights into the amount of correlation between variables.

Multiple linear regression

For more complex relationships between two or more independent variables, businesses can get a deeper understanding of their business using multiple line regression. For a business example, variables could be social media spend, economic conditions, and competitors.

Types of qualitative financial forecasting

These types of forecasting methods rely on more subjective variables and expert opinions.

Market research

Market research plays a crucial role in predicting your business success, from researching competitors to checking the demand for a product or service. Here are a few examples:

• Analysing customer behaviour - such as their preferences, purchasing habits and trends, which all help businesses to make better informed financial decisions

• Researching competitors - by analysing similar businesses, you can identify potential threats to your bottom line, alongside competitive pressure and market dynamics

• Demand assessment - researching market demand can help with inventory management and production planning, all which have an effect on expenses

• Deciding on the best prices - getting a better idea of pricing helps you predict your future revenue, for example if you have to lower your prices to stay competitive

• Risk management and planning - having a contingency plan factored in can affect your forecasting, so research risks in your industry and any future challenges 

In short, incorporating market research into financial forecasting allows businesses to create data-led, more accurate forecasts, which take customer expectations fully into account.

Delphi method (expert consultants)

The Delphi method is a way for experts to collaborate remotely, share expertise, and arrive at a collective forecast together. It particularly helps businesses in uncertain market conditions, or when they need to make sensible and balanced decisions in more complex situations.

It’s like a group discussion of knowledgeable individuals, eventually agreeing on an answer.

1. Survey - the group of experts are presented with a survey or questionnaire relating to a problem. Each person gives an answer separately, not seeing each other's opinions.

2. Feedback - a facilitator compiles the responses and sends them back to the participants. Then, everyone can review and reconsider their own answers again.

3. Repeat - the survey and feedback rounds are repeated, until the experts reach a collective opinion. People may adjust opinions after seeing the full picture.

This method of financial forecasting can help a business tap into the collective knowledge of its experts. It minimises dominant voices from overwhelming quieter participants, allowing objective and honest opinions to be shared, and its multiple rounds help find a solution.

If there’s a lack of historic data, the Delphi method can help a business make a decision.

How to create a financial forecast: four top tips

A good financial forecast model requires the right tools - this will allow you to make and change your forecasts easily. One of your best tools is a spreadsheet, so it’s wise to get familiar with how they work. 

Using formulas and variables can simplify your life a lot, and an accounting package such as QuickBooks Online can help you create a forward-looking budget with its automated features and reporting capabilities.

Understand what drives your business revenues and costs

To make accurate balance sheet forecasts, you need to understand the source of your revenues and the fundamentals of your costs. A revenue or cost driver is a unit of activity that causes a change in your revenue or cost.

For example, say your business produces shoes.

• On the sales front, your revenue drivers are the number of shoes you sell and the price at which you sell them.

• On the cost front, your cost drivers might be the amount of material and the cost of the material to produce the shoes.

• Other cost drivers are the number of hours it takes to make one shoe and the wages of the employees producing the shoes.

Cost drivers allow you to turn all your products and services into smaller components and attach a price to each. Then you can make forecasts based on what you know about each cost driver on a monthly, quarterly, or annual basis. If you plan to seek investments, you should be aware that investors often determine how well you know and understand your business based on how well you define your revenue and cost drivers.

Adjust your forecasting model often

Adjusting your forecasts frequently based on your experiences and results can give you a clearer picture of how to move forward. While your first projection may be overly optimistic or pessimistic, you can gain more accuracy once you begin collecting real information about sales and costs. 

Using real information for updating your assumptions about revenue or cost drivers can improve your financial forecasts. If you expect to sell 500 pairs of shoes but only sell 50, you can update your forecast to something more reasonable until sales start taking off.

Keep financial projections simple, realistic and useful

“Keeping things simple and being realistic are key factors for having a useful forecast for good decision-making.”

When starting out, it’s wise to keep things simple. Looking at your core business from different angles makes it easier to see the path to profitability. If things aren’t looking good, taking some time to reevaluate your drivers and making new decisions can help increase your pace toward higher profits.

Being realistic helps, too. No matter how great your idea, unless it’s unique, you might not be able to get 10% of the known market in year one and 20% in year two. Making unrealistic assumptions might make you profitable on paper, but in reality, it usually doesn't happen.

Ultimately, you want a useful forecast for good decision-making. Your financial forecast should tell you how profitable you may be and what variables need changing to become more profitable. Only when you know these performance indicators can you take action through increasing sales, raising a product’s price or reducing costs.

Factoring in your forecasts when building your expansion strategy for new products or territories gives you a greater opportunity for success. Keeping a close eye on your forecasts lets you know if you’re moving too fast or getting too big.

Having the best tools for forecasting, analysing, and tracking what goes on in your business increases the odds of your business success. 

Join them today to help your business thrive  for free.

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We hope you’ve found this article useful. QuickBooks can help you create your financial projections, saving you time and research.

Read more articles about finance, budgets and cash flow on the QuickBooks blog.

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