Why Financial Forecasting Is Important for Startups and How to Do It Right?

What is Financial Forecasting?

Financial forecasting is a fiscal management tool which analyses history of your business, previous and present trends in order to estimate or project likely future income or revenue and expenses and is quite critical for business success. If you have not done the financial forecasting well in advance, you would be lost as a traveler on a new journey is lost without a route map or travel plan.

A financial forecast is to a business what a detailed map is to a sailor and without it, most likely you will end up navigating the shallow and choppy waters of the business world. The old adage “cash is king” is all the more important if you are a start-up because not many start-ups venture into the entrepreneur world with a solid financial back-up and as a matter-of-fact, most of them start with a very little fund at their end. If statistics have to be believed then the lack of planning and control of cash resources is one of the prime reasons why the small businesses fail.

Also Read: Financial Reporting Standard

Although industry experts do understand that when you are launching a new business or venturing into a new market for the very first time, planning your finances is not the most exciting aspect you would like to look into, but sadly enough, they can’t help but to emphasize as much on financial forecasting as on any other aspect of starting your business. And it is not only the start-ups who are advised to do financial forecasting, but also the medium sized as well as large sized business must also practice it, because in their case financial forecast will identify trends in historical data, generated from both the sides i.e. inside and outside the business and generates an accurate insight on how the business’ financial status is going to be at various points in the coming time.

Importance of financial forecasting

What makes financial forecasting an important and indispensable part of any start-up is the mere fact that it gives you an insight of future business conditions likely to affect your business and thus give you an opportunity to be ready with contingency plan(s), rather than getting caught by surprise. Also, it is important to make financial forecast an important as well as routine affair of your business because business world is a dynamic one and the variables are changing on a monthly basis, if not hourly or daily. So the conditions i.e. the market response, inflation etc. are bound to get changed with time, some of which are completely out of your hands. Also, a monthly forecast will give a real-time view of what you should expect to happen as per the recent happenings or events of your business.

Also Read: How to Fund Your Startup

Important elements of StartUps

As a start-up, you must remember that there are certain elements of your business and if you can project or allocate certain numbers or figures to these elements, you should be make to make a fair financial forecasting of your start-up.

The basic elements of most of the start-ups are:

• It has some regular costs.
• It has certain direct costs attached with its regular income.
• It has some occasional costs and purchases.
• It may have some borrowing and repayment to make.

By and large, most of the start-ups begin with these basic elements and before you start with your operations and building on your clientele, it is advisable to allocate certain figures to these elements for the reason mentioned above. There are more than one reason why the industry experts and those who are running their business successfully vouch for the financial forecasting, some of them are listed as below:

1. It helps you to set your sights: It is a no-brainer that you must always know where to go i.e. your destination before start working on how to reach there, because if you aim for nothing, then that’s probably you will get. With the help of a financial forecast, you will get a good insight into the required resource requirements and milestones needed in order to reach your goals.
2. It helps to benchmark your progress: Once your business has picked up its pace and if all is well in the paradise, it is quite obvious to get off-track at times. But if your financial forecasting is at its place, then you can compare it against the actual results and in case there is a deviation, it will give you the required insight to make the needed and applicable changes in order to set your business back on track.
3. Making important decisions: For your business to continue sailing in the right direction and towards its goal, it is important that you make informed and right decisions, as and when needed. By a large extent, the accuracy and correctness of your decisions depend on your understanding of the business, which is only possible if you have doing financial forecasting on a timely basis.
4. Required finances: Cash or finances to a business is what oxygen is to human body and without the former one, a business will die its natural death. Financial forecasting, apart from setting your insights, also plays a vital role in calculating the financial needs i.e. a fixed or working capital for your business and with so many variables attached to a start-up, you are required to have a fair idea of required capital in order to continue its daily operations as well as to expand.
5. Highlighting driving force: Apart from your zeal and passion, every start-up has its key drivers attached to it and in order to have a successful business, you must know their impact on your business and on the results you are striving for. A well-built financial forecast not only highlights the key drivers of your business but also tell their possible impact on the set benchmarks.
6. Management of cash flow: Starting your business is one of the easiest things you can think of, but the real catch is to sustain and thrive in it. Lot many start ups vanish from the surface of earth not because there was a dearth of cash or funding, but only because they were not able to manage their finances well. In order to mark your presence in the business world, you need to manage your cash flow pretty well and one of the ways to do that is have a robust financial forecasting in place.

How to do Financial Forecasting for Startups?

There are various ways you can adopt for building a financial forecasting for your start-up however; a financial forecast need not to be compiled in a sequence and what matters is the factors you have taken into account while building one because since a financial forecast is totally based on your predictions and assumptions, you are likely to jump back and forth multiple times while working on it. However, in order to do it right way, you should work in the following sequence:

• Start with a sales forecast: In order to set your business on track, it is important to have your sales forecast done accurately and in order to do so, you must decide on what you are going to sell because what and how much you sell is going to decide your success. While working on sales forecast, you must neither overestimate nor underestimate sales and in exuberance most of the start-ups end with overestimating their sales, which is nothing but a cardinal sin as far as your start-up is concerned. So, you must keep your sales forecast as simple as possible and include list of the types of products and services you are planning to sell along with placing an estimation of volume and price for each category.
• Create an expenses budget: Once your sales forecast is in place, you are pretty much aware of what you are going to sell and its volume as well. So, your next step is to calculate your costs, which is quite easy to calculate and while doing so, you must include both fixed and variable costs.
• Develop a cash-flow statement: At this step, you will get to see the cash coming in to your business and cash going out and it is advisable to break the cash flow statements in12 months for the start-ups.
• Income projections: This is the point which decides the future of your start-up and thus it is important to use the numbers you have put in your sales forecast, expense projections and cash flow statement because as per simple calculation, sales less cost of sales is your gross margin and later minus expenses, interest and taxes is your net profit.
• Deal with assets and liabilities: While building your financial forecast, you must be careful enough to not to miss out on assets and liabilities because where there are some obvious one affecting you only in the initial years, there are certain not obvious ones such as repayment of loan, which affect your business later. So a better way to do is to start with your assets and estimate what all you have on hand and then include your liabilities i.e. the debts.
• Breakeven analysis: A breakeven point of any business is a point where its expenses are matching your sales i.e. the revenue and it is important to give a timeline to reach the breakeven point for your start-up. It is important to include and have breakeven analysis in your financial forecast not only to ensure that you are navigating in the right direction, but also to get potential investors on board, because everyone would like to invest in a fast-growing business with an exit strategy.

About the author

Sumit Agarwal
Sumit Agarwal (ACMA ACA India), the Managing partner of dns accountants is a highly respected accountant with expertise in helping owner-managed businesses.