Financial Forecasting - The Critical Tool Often Overlooked by Small Businesses

Posted on January 27, 2025 by Greg Tilley, One of Thousands of Business Coaches on Noomii.

All large and mid-size businesses use financial forecasts and budgets to manage their organizations. Why do they go to so much trouble when there is no government or compliance requirement? Because they work. Small businesses that don’t use these tools are flying blind. As the saying goes, when you fail to plan, you plan to fail.

What is the difference between forecasting and budgeting? For the purposes of most small businesses, it does not really matter much, but here is an attempt to make that distinction. A forecast is what you project is likely to happen. A budget is what you want to happen. Typically, a forecast will have several iterations, including best case, worst case, likely case and desired case. The budget is then derived from the desired case.

Here are common objections to forecasting given by small business owners or executives:
1. We don’t have bandwidth.
One of the reasons that small businesses don’t have the bandwidth is that they have not set out a plan for the year that focuses themselves or their team on what is important. The process of forecasting and budgeting helps the staff avoid spending time on things that are not critical to achieving the budget.
2. We don’t have the expertise.
While there are sophisticated software tools available for forecasting and budgeting, for small businesses they don’t provide much advantage over a simple spreadsheet. There are plenty of free do it yourself templates.
3. Forecasting is just trying to guess the future. How do I know how much revenue I will have next year?
Forecasting isn’t guessing the future. A good forecast identifies the likely future (and possible upsides and downsides). That forecast is used to establish a budget, which is the future you want to happen. The budget sets a revenue goal and reflects all the actions and resources required to get there. If used properly, the forecast and resulting budget will guide decision making throughout the year so that the likelihood of meeting the budget is greatly enhanced.

Forecasting and budgeting are typically undertaken at the beginning of a fiscal year of an ongoing business, or in the planning stage for a new business or launching a new product or service, but may be conducted any time. Here are typical steps in the process:
1. Decide what format will be used. A simple P&L format is the easiest to manage and understand for a small business. Revenues and expenses are itemized by row, and months or quarters in the columns. If cash flow is a critical concern, then a cash flow format should be used. With a good forecasting tool, you can get both.
2. Create or obtain a template and begin populating based on last year’s numbers and project your best estimate of next year’s performance. Don’t guess. Make your best estimate based on your assessment of market trends, your competition, your backlog and expected future orders. Also consider what might change on the cost side from last year – rent increase, wage increases, insurance, supply pressures, etc.
3. When you have evaluated some best, worst and likely case scenarios for both revenue and costs, then switch hats and decide what you want to happen in the next year. That is the ‘desired’ case and will become the basis for the budget.
4. Consider what new expenditures will be needed to hit the ‘desired’ case revenue targets. Will you need more inventory, new staff, new equipment, or more advertising? Make sure the costs of those items are in the projection. Save that version and label it ‘Budget – Final’.
5. The Budget will guide decision making and investments through the year, while also providing a benchmark for evaluating progress and implementing incentive plans. Forecasts can be reevaluated and may change during the year, but avoid making changes to the Budget, particularly if it is tied to staff accountability and incentives. Actual to Budget comparisons may be evaluated monthly, or at least quarterly, to monitor progress.

Involve your team in the process. If they have a hand in setting the numbers, they will be invested in the outcome. You will have a much higher probability of meeting your business objectives with this approach than by setting arbitrary targets.

This is a quick guide to the what and why of preparing financial forecasts and budgets. Use the resources below to get started. If you need help, contact me on Noomii.