Financial forecasting is a vital part of business planning. Although many events affecting your business are unpredictable, it is still possible to use forecasts to guide your decision making, exploit trends and give your business a competitive edge.
In order for forecasts to work for your business, they need to be realistic. You can use existing financial statements as a guide. If you are a new business, you may want to work with a business adviser to develop your financial forecasts.
Profit and loss forecast
A profit and loss forecast shows the expected revenue and expenses for your business over a period of time. It shows how much profit is likely from a predicted level of trading.
Producing a profit and loss forecast involves listing your planned expenses and calculating the sales targets needed to reach your profit goals. You can then check your forecast regularly to ensure your business is running according to plan.
You can compile your profit and loss forecast in the same format as your profit and loss statement. This will allow you to compare them later and refine your projections for the future.
It's important to note that a profit and loss forecast does not reflect your liquidity. It contains non-cash items such as depreciation, creditors you have not paid, and invoices raised but for which no cash has been received. It also excludes any payment of loans.
To get an idea of your business's likely cash position, you will need to create a cash flow forecast.
Cash flow forecast
A cash flow forecast is an estimate of your business's cash inflows and cash outflows over a period of time (but usually covers 12 months).
Cash flow forecasting is a management tool that predicts cash surpluses or shortages. You can use a cash flow forecast to find out if you will struggle to pay your debts or taxes when they become due, or if you can afford to make a major equipment purchase or take on more staff.
By setting up your forecast in the same way as your cash flow statement, you can compare your predictions with your actual performance. This will alert you to any variances, which you can then investigate and find out why you business is under (or over) performing.