Financial Forecasting: What Every Small Business Owner Should Know
Writen by: Pretha Yasmin
Financial forecasting is the process of estimating a company’s future financial performance including revenues, profits, and cash flows based on its historical performance and educated assumptions about the future. Running this type of forecast helps business owners make informed decisions about short-term priorities like making sure they have cash for payroll or that they’ll make a profit this year. It can also help with long-term decisions about investments, hiring, acquiring another business or expanding to new markets.
Building a forecast for your own business is straightforward and gives you the visibility to make major financial decisions, like hiring new staff or purchasing equipment with confidence. Here’s what you need to build one and some of the ways you can use it to manage your business.
How to do a financial forecast
To do a financial forecast, you use your historical financial performance to make reasonable assumptions about what will happen in the future. If you don’t have a program or app, the easiest way to create one is to put everything into a spreadsheet so you can see how your finances look across different time horizons. This also lets you see how numbers like profit and cash flow change when you adjust things like sales or expenses.
What’s needed for a financial forecast
To do a financial forecast you’ll need:
- Historical income statements (2–3 years if possible)
- Past sales data broken down by whatever time period best fits your business. Convenience stores would look at daily or weekly while financial services might look at monthly or quarterly.
- A list of all fixed expenses like rent, insurance, or loan payments.
- Variable expenses like advertising, subscriptions, or supplies.
- Estimates for major equipment you will need to purchase or replace within the time of your forecast.
- Two spreadsheets to organize and calculate the forecast.
Pro-tip: You can use AI tools to do this for you, just double check their work as it may not always be accurate.
Steps to create a financial forecast
To do a financial forecast you will set up two spreadsheets with the same time periods and use one to do a profit and loss (P&L) forecast and the other to do a cash flow forecast.
You need both because P&L is your paper profit whereas cash flow is money in and out of the bank. If you see the cash flow forecast turn negative, that signals a potential cash crunch ahead — and an actual negative bank balance could trigger loan defaults or even bankruptcy.
Set up the two spreadsheets with individual rows for sales, expenses, or cash flows and make the columns daily, weekly, or monthly depending on what’s right for your business. Then use this 5-step process to do a financial forecast:
- Map when sales and cash come in.
- Map when expenses and cash go out.
- Add up the difference between 1 & 2 for each time period.
- Calculate your forecast.
- Identify risks and stress test.
Map when sales and cash come in
Map where money is coming in by entering your invoice or sales amounts on the P&L spreadsheet in the column where you would recognize the sale. Then adjust it on the cash flow spreadsheet for when the money actually hits your bank account. If you make credit card sales on Tuesday, the cash may be in your account Thursday. If you invoice customers with net-90 terms, you make a sale in March but you don’t get the cash until June.
As you’re entering data, use formatting like cell fill colors, fonts, or borders to mark things like customers that have a risk of paying late or large credit card purchases or time periods where you might have higher than normal chargebacks. This lets you identify them easily later in the forecast when you stress test.
Map when expenses and cash go out
Repeat the previous step for expenses and adjust the dates cash actually leaves your business checking account. You might expense inventory as it’s sold but pay your vendor a month later. When you enter expenses and outgoing cash flows, use negative numbers in your spreadsheet so it is easier when you do the final calculation for each column.
Make sure you include non-cash expenses like depreciation on the P&L spreadsheet since they impact your profit. Put cash outflows like debt principal payments and equipment purchases that aren’t expenses onto your cash flow spreadsheet so you don’t get surprised by a large cash outflow in the future just because it wasn’t an “expense.”
Add up each column to see changes for that time period
Use the “sum” function in your spreadsheet program to add all the values in each column. If you do weeks in your P&L spreadsheet, this will give you the weekly change for pre-tax profit since you don’t determine taxes that often. The cash flow spreadsheet gives you net cash flows for that week.
Calculate your forecast
To calculate your forecast, use the first time period’s P&L change as the starting point and then add each following period’s net change. This gives you a running forecast showing how your pre-tax profit changes over time.
For the cash flow forecast, use your current bank balance as the starting number and add the first period’s net change, then continue adding each subsequent period’s net change to see how your balance evolves over time. If you see the cash flow forecast turn negative, that means you’re looking at a cash crunch and need to take action by cutting some bills, speeding up invoice collections, or finding a short-term business loan to cover the gap.
Identify risks and stress test
The last step is to find risks and where sales might come in lower or slower, expenses could be higher, or unexpected emergencies come up. This helps you know whether you have a problem and if you do, gives you time to start working on it now. It also helps you make and time decisions like when to pull the trigger on major purchases or how to pace hiring new people.
Start by looking for the risk items you formatted in the first two steps. Move customer payments later, lower sales numbers, raise expenses, and watch how this changes both your P&L and cash flow spreadsheets. If the running forecasts for both spreadsheets are within your comfort levels even after you have adjusted for risks then your financial forecast is strong.
If you see time periods where your financial forecast drops below your comfort level then it’s time to stress test and enter contingency plans. If you have a period where cash flow goes negative, you could try raising prices in advance as long as it doesn’t cause too much customer churn. This might cost you some customers, but the total price times quantity after the price raise might be enough extra revenue to overcome the negative cash flow.
Now that you know how to do a financial forecast, here are a few examples of how you can use yours.
Ways to use your financial forecast
Some of the ways a financial forecast can be used by a small business include:
- Using it as a starting point for employee costs, then adding new payroll to see how profit and cash flow change as new hires ramp up. This could identify exact timing to space out hiring so you don’t have too big of a financial hit at one time.
- Timing equipment purchases by seeing where you have room to fund down payments or full purchase price from existing cash flow or whether you need an equipment financing loan.
- Making depreciation decisions between bonus depreciation, section 179 elections, or other depreciation methods by seeing how they impact the financial forecast to your P&L and your cash flow side by side.
- Finding investors by showing them the growth potential and how they can earn a return on investment in exchange for putting money to work in your company.
Financial forecasting is the process of estimating your future revenues, expenses, and cash flows over a specific time period to see how they rise and fall based on how you change different things in your business. This gives you visibility into your future growth, supports sound financial decisions, and helps you avoid cash crunch emergencies.by seeing cash flow gaps before it’s too late to make payroll or meet a debt payment.
SmallBusinessLoans does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal and accounting advisors.
