purpose of financial forecasting

Why It’s Necessary to Forecast Your Financials

The future is unpredictable. That’s the only thing that’s certain about the future.

You probably saw that statement coming.

Some businesses let fear of the unknown dictate their work. Or, more specifically, their reluctance to work on certain things. They feel that since it’s impossible to know what the future holds, there’s no reason to plan for it.

That’s why many of them don’t make financial forecasts.

In some ways, that’s understandable. The future’s a far-off outlook, but business is happening now. Why devote resources to speculation when there’s more tangible work to do? Especially since, as we’ve established, the future is unpredictable.

But not taking time to forecast your financial growth can be a grave error.

The future may be unpredictable, but that doesn’t mean it’s unmanageable. Having a sense of what should happen helps you steer your company in the right direction. Even when surprises come up. This is the purpose of financial forecasting.

Why Not Forecasting Your Financials Is a Mistake

Forecasting financials is a resource-consuming process. It doesn’t erase the uncertainty of the future. And it’s easy to become unduly optimistic or gloomy about projections.

But avoiding financial forecasts is a mistake for several reasons.

Lack of Direction

Every business needs a plan, a road map. It’s hard to thrive in an aimless or chaotic environment.

Without a financial forecast, a business wanders toward an unknown goal. It doesn’t recognize benchmarks when it reaches them. It works toward a generalized, unclear net income. And it’s unprepared for sudden events that influence results.

No Data Analysis

It’s impossible to measure your business’s financial results with a forecast in hand.

Financial reports have no impact if nobody knows what the expectations were. Whether weekly, monthly, or annual, reports can’t be evaluated without a standard to refer to. You can’t interpret the data that powers every successful business in the world.

Wrong Price Points

With no direction and no analytics, you can’t determine how much money you should charge.

You may price your product or service below what you need to break even. Or you may set prices that are too high for lack of demand. Either way, without a forecast, you won’t know until your product or your cash has left the building.

How Forecasting Your Financials Helps Your Business

A financial forecast doesn’t have to get every detail right down to the last cent. I’d be shocked if one ever has.

But that’s not the point. The benefits of a well-reasoned forecast are more aspirational. They help you chart your business’s course.

Sets Net Income Goalsprofit goals

If you have a sense of how you expect your business to perform, you have a target to meet or exceed. That makes your objectives easier for employees to understand.

Sets Expenses

It’s much easier to manage overhead when you have a financial forecast. You get a clearer picture of what you’ll need and why. You can allocate resources more effectively. And you can make data-backed decisions on where to add and where to cut.

Establishes Profit Points

The purpose of financial forecasting helps management set targets. It clarifies where gross margin percentage should cross the break-even point. This allows you to set minimum prices that make sense to your customers and your accountants.

Streamlines Inventory and Services

If some of your products or services can’t reach that break-even point, it’s fruitless to offer them. With a financial forecast, you might see those situations develop in advance — and make smart decisions before they impact your bottom line.

Sets a Tone for Your Company

financial toneEvery company needs a sense of direction. It needs to have a set of expectations. Employees work better and feel better when they have focus.

A financial forecast isn’t a promise (or a threat, for that matter) — it’s a prospect. And it powerfully defines your company’s direction, operations, and culture.

That’s as close to a solid prediction about the future as you can get.

Need assistance in forecasting? Talk to one of our Virtual CFOs today!

 

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