If you’re at the head of a startup or fast-growing business, you likely have big visions for your company's future. If you're serious about taking your company to the next level, dreams are just the beginning.
To truly break barriers and reach your most ambitious goals, forecasting plays a vital role in shaping the future of your biz. It's not just about having a solid grip on your finances and budget but understanding the immense power of forecasting and its importance in achieving your loftiest goals.
Whether you complete your accounting services in-house or outsource it to a reliable service provider, forecasting is a powerful asset to explosive (and sustainable) growth.
When it comes to understanding the importance of forecasting, many questions might come to mind, such as:
- How is forecasting different from other financial processes, like budgeting?
- What does it involve, and what methods can you implement?
- Most importantly: how can forecasting positively impact your business?
For each question, we're going to take a deep dive into the details of forecasting and its crucial role in determining the success of your outcomes. Let’s get started!
What's the Difference Between Forecasting and Budgeting?
Let’s start with the basics: what exactly is forecasting, and how is it different from budgeting? Sometimes, the terms "forecasting" and "budgeting" are used interchangeably, but the reality is that these are two separate processes.
Forecasting and budgeting are financial "tools" that can help startups develop and implement a winning plan for their business. But they both use different approaches to achieving those goals.
Mainly, budgeting involves creating a static plan, which details the general financial direction of the company, including how much revenue and expenses are expected during a set period. (It’s typically done only once a fiscal year.) On the other hand, forecasting predicts what the financial future of a company might look like based on historical data.
Here are some other significant differences between the two processes:
- Companies create budgets to meet a specific goal, while forecasts assess whether the company can meet the budgetary goal.
- A budget is generally based on past trends or business experiences. While a forecast considers such things, it also examines several other key factors in its analysis (such as the company's current financial situation, market trends, conditions, and so forth).
- A budget is often developed with a "set it and forget it" mindset. Forecasting is done frequently and is thus more flexible than a typical budget.
You could boil down the differences between budgeting and forecasting into the difference between a set of printed driving directions and a GPS. The printed directions provide one way to reach your destination. If unforeseen circumstances arise (like a road closure or a traffic jam), the GPS can provide multiple routes for your course.
In the same way, a budget may focus on the right goals but may lack flexibility in the face of changing market conditions. On the other hand, regular forecasting can help you adapt and quickly "change course" if needed.
Budgeting and Forecasting: a Match Made in Heaven
As we just touched on, budgeting and forecasting have some distinct differences. If this is the case, why are they often mentioned together? Budgeting and financial forecasting can work hand-in-hand to give leaders a complete financial picture of their company and ensure they make the best financial decisions.
The truth is that budgeting can be useful for startups, but it might not be wholly effective as a standalone process.
In fact, budgeting often works best when it’s used tangentially with financial forecasting, and the two can complement and support one another. Because budgeting is typically static, it can quickly become ineffective if variables become too volatile.
For example, a budget might outline certain goals, but they might not be possible due to tumultuous real-world market conditions. If decision-makers used a static budget alone to make decisions, they might not pan out as intended. But if they use financial forecasting, they can have a more realistic and accurate projection and make the best-informed financial decisions.
Forecasting is likely what you're looking for when it comes to making the best financial decisions for your business. But it’s important to note that budgeting can still benefit businesses (particularly startups).
Budgets can be excellent blueprints for setting aside financial resources and identifying contingency plans. They can also keep you on track with your essential business financial needs, such as tracking spending and understanding your necessary expenses.
What Falls Under Forecasting?
It's important to note that financial forecasts (like weather forecasts) are predictions based on conditions that may change at any moment. Therefore, the best forecasts include as many variables as possible in their calculations. In addition, it's always a good idea to look at best-case and worst-case scenarios throughout the forecasting process.
Here are a few of the critical elements that make up a comprehensive forecast:
- Historical data. Previous data, trends, and experiences should be included in any forecast as a "baseline" for what to expect.
- Current conditions. Examine your company's current situation as a balancing force set against historical data. For instance, it's good to ask the question: What's different now compared to a year ago?
- Macroeconomic risks. No one can predict when a major global event like a pandemic or natural disaster will occur. However, the best forecasting models consider the effect such catastrophes would have on the market if they occurred.
- Internal risks. Companies often have "blind spots" regarding risks from within, whether they involve deliberate fraud, high-level mismanagement, or other issues. Exceptional forecasts will consider such risks (no matter how remote).
- Anticipated and unanticipated costs. Effective forecasting will include anticipated expenses (office rent, CFO services, cost of supplies, etc.) and unexpected expenses that may arise suddenly (e.g., a cyberattack that causes your company to lose valuable data).
- Best-case and worst-case scenarios. Finally, your forecasting model should provide a fairly detailed description of the outcome if everything in your plan goes right (best-case scenario) compared to everything going wrong (worst-case scenario). While the reality may be somewhere in the middle, it's good to be prepared for both extremes.
What Are the Different Types of Forecasting?
Four methods of forecasting are commonly used by companies today. Sometimes businesses only implement one of these types, but in many cases, they combine two or more techniques for a more comprehensive report.
Take a look at these forecasting types below.
1. Straight-Line Forecasting
This is the simplest forecasting method and only involves basic math and historical data. The idea is to see if the company's growth proceeds constantly over time. For example, if a company has consistently experienced 10% year-over-year growth for the past three years, straight-line forecasting can predict how the company will look in the next year or two if that trend continues.
2. Moving Average Forecasting
The moving average forecasting model is easier to update than the straight-line method since it analyzes time frames shorter than a year (e.g., quarters, months, weeks, or even days). This forecasting type helps identify underlying patterns within the scope of the time frame. For example, a moving average forecast can help retailers determine which products to order from vendors during peak times of the year (such as the holidays).
3. Simple Linear Regression Forecasting
This forecasting type tracks the relationship between a dependent and independent variable. For example, imagine a company wanting to identify trends around its average sales volume (x-axis) and profit margin (y-axis).
If the x variable is rising (that is, sales are increasing) but the y variable (profits) is holding steady or decreasing, that could indicate that rising supply costs or narrow margins hinder a better outcome. On the other hand, if sales are down but profits are up, that would reveal a positive trend (perhaps due to higher profit margins or lower supply costs).
4. Multiple Linear Regression Forecasting
This is similar to simple linear regression forecasting in the sense that it tracks the relationship between dependent and independent variables. However, this model uses multiple independent variables (known as parameters).
As you can imagine, this forecasting method can get really complicated quickly. However, when set up and implemented correctly, multiple linear regression models can provide your business with some of the most detailed and accurate predictive data.
At the end of the day, both simple and complex forecasting methods have their place. Intricate models that factor in a wide array of variables will obviously provide a better-defined view of your financial projections.
Nevertheless, more straightforward methods are helpful when making a (relatively) straightforward decision. You can always "mix and match" forecasting methods to create a framework that suits the unique needs of your business—for instance, using straight-line data as one of your variables in a multiple linear regression model.
Forecasting Tips for Startups
When it comes to startups and other growing businesses, just about nothing is “textbook.” And that includes financial forecasting.
With that in mind, here are some insider tips and tricks that startups and other growing businesses can use when using financial forecasting.
Make the Most of the Data You Have
Forecasting often relies on historical data, and for your forecasting to be as accurate as possible, your historical data needs to be as precise and detailed as possible. This is particularly important because new startups often don’t have a ton of historical data to work with.
To ensure your data is useful for forecasting, it’s vital to get your accounting and financial needs in order. For example, you should have an excellent handle on your bookkeeping, and a professional should take care of your business taxes.
Before Making Major Decisions, Turn to Forecasting
Startups tend to run fast, and quick decision-making is often the name of the game. But even if you think you have a great handle on your budget and feel confident about a decision, you shouldn’t take the plunge without turning to financial forecasting first.
Forecasting gives you the most accurate predictions possible so that decision-makers can formulate realistic winning strategies. Forecasting is the difference between risks and opportunities when it’s time to make big decisions.
Know the Importance of Forecasting
Financial forecasting isn’t just useful for big-picture decisions, it’s important to know how exactly it can benefit your business. For example, if you’re courting new investors and looking to sell them on your value proposition in the marketplace, financial forecasting can be your new best friend.
Forecasting is also helpful for showing financial institutions and other creditors that your company is fiscally responsible, which can be incredibly helpful for achieving upward movement regarding loans or lines of credit. It might also come in handy during your startup’s due diligence process.
Forecasts Are Made to Be Broken
Okay, not exactly, but hear us out. Forecasts are predictions about the future, which (of course) is uncertain. Infinite variables at play can sometimes manifest in completely unexpected ways.
Because of this, forecasts often need to be revisited and revised, and it’s usually practical to create several different forecasts which account for different scenarios. But that’s the beauty of forecasts (and one of the downsides of budgets): it’s possible to revise them as often as needed.
Should You Outsource Your Forecasting?
Deciding what to outsource and handle internally can be a big decision for startups. Resources might be tight; in many cases, trying to take on some things yourself might seem attractive. However, when it comes to financial forecasting, outsourcing is the answer.
Here are a few reasons why:
- It requires close monitoring of finances: The revenue and costs of startups can be challenging to predict, especially during times of rapid growth. An outsourced financial forecasting provider makes it their full-time job to produce and track your monthly reporting (which is then used for financial forecasting), so you don’t have to.
- One forecasting model likely isn’t enough: Forecasts rely on variables, and because of this, simply creating one financial forecast likely won’t get the job done. You might need to create several different forecasts, for example, and they might need to be updated as time goes on. This can be a significant burden for an already-strained in-house team.
- Forecasting goes great with other financial services: If you’re already outsourcing things like your business taxes and bookkeeping, you’re well-prepped to have an outsourced financial partner handle your forecasting. If you’re working with an outsourced CFO, they can conduct financial planning and analysis, among other things.
Forecasting: Why It's What You Really Need
Forecasting is an essential component of a rock-solid financial strategy. While the budgeting process faces the past by creating goals based on historical data and trends, forecasting focuses on the future by predicting forthcoming revenues, expenses, and cash flow.
Forecasting is more valuable than budgeting (especially as a standalone) because it takes variables into account, such as market conditions and other fluctuations.
Business owners and executives can lean into financial forecasting to make confident, well-informed business decisions, from staff levels to inventory needs, production quotas, etc. Depending on how frequently you run financial projections, you can even make "hairpin turns" in the company's direction, resulting in a higher profit margin and a greater competitive edge.
Forecasting should be baked into any company's monthly financial reporting, whether in-house, outsourced, or hybrid. In 99% of cases, frequency and consistency are the two keys to forecasting success. When projections are regularly updated within a consistent schedule and framework, you can spot trends early and make important adjustments.
Take Your Startup to the Next Level With Forecasting
Knowing the importance of forecasting is key to an effective financial strategy, especially for startups looking for powerful growth. While both budgeting and forecasting are essential processes, the latter is more flexible, practical, and forward-looking.
There are several kinds of forecasting models that your company can use, from simple straight-line projections to complex algorithms. Forecasting can help you to make confident, well-informed decisions about the direction of your business.
While forecasting can sound like a lot of work to get done (and to get right), you don’t need to tackle it alone. We provide fast-growing businesses with robust outsourced financial services, including financial reporting and analysis.
Don’t leave the financial future of your business up to chance; instead, have the valuable forecasting data you need to make the best business decisions possible. Contact us today to get started.
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