Business forecasts are an essential planning tool for small business owners and they are usually required by potential lenders and investors. With meaningful forecasts to help predict results, businesses can plan more easily and accurately, as well as boost the confidence of potential investors and lenders. Because of this, smart business owners who are skilled in creating forecasts have an edge over their competition. So let’s go over what it takes to create a realistic business forecast.
Determine the Time Frame of Your Forecasts
The time frame for your forecasts should be determined based on your own forecasting knowledge, and your business and industry experience. If this is your first business forecast — or if you’re new to your industry or new to running your business — then it’s best to set your business forecast for three months out.
It’s tempting to try forecast out a year or more, but the truth is that you probably won’t be very accurate. Even experienced business forecasters know that over a year, important factors can change. This means a one-year forecast is quite likely to be off the mark by year’s end.
The more predictable and stable the economy and market conditions, the more accurate a forecast can be – so it makes sense that the shorter the time frame, the more accurate the forecast. It’s far easier to predict what conditions will be like over the next three months versus over the full year.
Identify Your Business Expenses
To create a forecast you must first identify all the expenses your small business will incur. Your business expenses will include costs such as electricity and heat, as well as product manufacturing costs. Itemize them and separate them into the fixed costs for operating your business and the variable costs related to producing your product or service. Often, small business owners will forget to include some of the less obvious costs like insurance, transportation, heating, or rent in their business expenses.
You need an accurate accounting of all your expenses because each one affects your bottom line, but there other important reasons to carefully track expenses. In addition to having an accurate prediction of what you can bring home in profit at the end of the month or year, potential investors will want an accurate read on what it costs you to do business. They want to know that your business is predictably heading in the right direction. Another reason you need all the details on your expenses is for tax purposes.
Here’s a list of some of the operating, or fixed, expenses you need to account for:
- Insurance that covers you, your employees, vehicles, office or store, and inventory
- Cost of doing business in your state (for example, are you paying to register as an LLC or C corp.?)
- Bills for electricity, heating, internet, phones, and water
- Cost for your website domain and hosting
- Employee salaries
- Accounting or bookkeeping services
- Any monthly subscriptions used by your business (such as web-based management software)
Here’s a list of some of the variable expenses you should account for:
- Marketing expenses
- Packaging
- Cost to produce goods (or to provide services)
- Cost to ship and return goods
- Inventory
There is another expense that many business owners don’t consider when creating a business forecast. This expense is the cost of your time. If you’re handling customer service issues, or office management, or other business functions, then you’ll want to determine what your time is worth, and how much time you’ll spend working behind the scenes for the business and factor that into your forecast.
Also, if you personally provide services, factor in what you would pay an employee to do this work and account for that as well. This doesn’t need to be included in an official report, and it shouldn’t be accounted for when doing taxes, but you need to have a record of what your time is worth, and you need to learn to forecast what your business will cost you in regard to time.
Once you have all of your expenses accounted for in your business forecast, there’s a simple trick to ensure you’ve accounted for everything: Double them.
Yes, it’s tough to hear, but almost every expense you predict is going to escalate beyond what you expected — even your time estimates. Doubling these numbers may feel devastating and it can be hard accept that these are your expenses, but most seasoned forecasters understand that plans are never perfect and they will usually apply this rule. While it may hurt now, doubling the expense prediction in your forecast and planning according to that expense figure, can help save your business — and it can help make you look more like a seasoned pro to investors.
Forecast Your Business’s Revenue
The strategy for forecasting your business’s revenue varies based on whether you have been in business for a year or more, or if you are a startup with less than a year’s worth of sales data.
If you’ve been in business for a while, then you can rely on previous years’ sales data to help you create a forecast. If you’re a startup and have no historical sales data, then you can look to Consumer Expenditure Survey reports and other industry data collections, and base your revenue forecast on data from these sources.
It’s important to remember that revenue forecasts are more ballpark estimates than accurate predictions. Also, you’re going to want to create at least two revenue forecasts: create a modest one based on expected revenue given poor market expectations, and an ambitious one based on expected revenue in very good conditions. This way you’ll have an idea of what business results could look like in less than favorable market conditions versus a more favorable climate.
How to Forecast Revenue If You’re an Established Business
Working off of your data for the previous year, you want to create a profile of the customers that contributed to creating 80% of your business revenue. Determine what age group, gender, ethnicity, and economic background these customers fit into. Now, take a look at the geographic locations you’ll be operating in within the next three months (are you expanding, downsizing?) and consult the census bureau to calculate how many customers you can expect in your region of operation.
You’ll want to factor in your competition too. In your region of operation, is there more or less competition than there was in the previous year? How much business do you estimate went to your competition in the previous year? It can be difficult to determine what another business is making. One way to do it is to estimate the business’s expenses (as you did above for your own business) and assume that the competition is making at least that amount in revenue.
Other variables that you want to factor in are seasonal adjustments, national and regional economic conditions, and where your business stands competitively in your industry.
How to Forecast Revenue If You’re a Startup
It’s much more difficult to create a revenue forecast for a startup business. The first step you’ll want to take is to find out what businesses in your industry typically make in a year and if possible, during certain seasons and months. A good place to start is the Bureau of Labor Statistics’ Industries at a Glance. You’ll also want to determine the price stability for your industry. You can do that by checking out the Producer Price Index.
Using this information, create a profile, also known as a persona, of your target customer. You only get to have one customer persona. This is because even if your product or service is applicable to many different types of people, in general, roughly 80% of most business’s revenue comes from one target persona, and that’s who you should base your forecast on. Once you’ve identified this customer profile, find how many of these people are in your region of operation.
From here, you will want to follow the steps above for forecasting revenue for an established business based on competition, seasonal fluctuations, and economic factors.
How to Forecast Revenue for Worst- and Best-Case Scenarios
It’s important that you create both conservative and ambitious revenue forecasts — these help keep your feet on the ground, yet give you exciting goals to aim for:
- Without the conservative revenue forecast, you could come up short on projections, lose investor confidence, and possibly risk bankrupting your business.
- Without the ambitious revenue forecast, there’s nothing to get excited about. You want something that you, your employees, and your potential investors can get excited about and aspire to.
A conservative forecast will be based on the least optimistic variables you can factor in. Ask these questions to determine your conservative forecast:
- What is the lowest price point at which I can sell this product or service?
- What if I were at the lowest end of my competition?
- What is the lowest possible number of target customers for this demographic?
- What is the least amount of sales fluctuation I can expect for this time of year?
- What is the lowest estimate for the number of people my advertising could reach?
To create an ambitious forecast, you’ll simply answer these questions — except that you’ll determine the answers based on a higher end estimate. So, what is the highest price point at which you can sell your product or service?
Pulling Together Business Expenses and Revenue
Once you have your revenue forecasts, and your expense forecast, you simply compare the two to determine your business’s profit forecast for the given time frame. As stated earlier, if you’re new to the industry, to running a business, or to forecasting, you should only forecast out three months.
When Your Business is in the Red
If you’re a brand new startup and your product or service isn’t yet ready for customers or clients it’s likely the numbers in your forecast show expenses exceeding revenue – you’re in the red. If the idea of losing money is scary, just know that it’s how most businesses start out. It’s true; most businesses lose money at first.
So, how do businesses survive if they lose money right out of the gate? They survive by raising capital.