Forecasting your company’s future for the coming year without quantifying it is like “just thinking” about exercising. They both have a negative impact on your health: your financial health in the first case and your physical health in the second.
The planning process is only valuable if you put numbers to your outlook; those figures in your forecast help you decide how to allocate resources for reaching your goals for this new year.
Start With Expenses
To simplify your financial forecasting, start at the bottom rather than the top. That is, project your expenses instead of your revenue. Start with categories that are fixed – or nearly identical – monthly amounts. Typical fixed expenses include rent, utilities, telephone, insurance, accounting services, marketing and wages. List each as a separate line on your spreadsheet, and place the same figure under a column for every month.
Next, make adjustments to some of these items that reflect slight variances that occur throughout the year. Utility costs, for example, vary seasonally; change each figure for utilities to reflect monthly differences.
Variable costs are trickier, especially for some types of businesses. These include materials, shipping, travel, sales staff, and cost of goods sold from inventory. Those expenses depend upon your sales volume. Start the forecast for this year by using variable-cost figures from last year. However, these numbers will change after you introduce a revenue estimate.
Two revenue cases
When predicting revenue, you may want to consider presenting two cases. One is the conservative case and the other, the aggressive one.
Conservative projections assume that you will follow the same trend as recent months. Forecast a continuation of the average percentage increase or decrease in revenue from last year. Follow up by making adjustments for monthly fluctuations; for instance, revenue may have increased substantially in the summer months compared to the prior year, but not changed in other months.
The aggressive revenue case assumes that you sell more or increase your prices – usually both. An aggressive tweak, for example, may also be required if you plan to increase your marketing expenditures; forecast more customers in the months during and after the increase.
The final forecasting step is adjusting variable expenses to match your revenue projections. Multiply last year’s percentage for cost of goods sold relative to revenue to determine expected cost for 2014. Your conservative case may plan for falling gross profit margin if inventory cost is rising. The aggressive case would presume that you improve gross margin, perhaps by acquiring inventory discounts when purchasing more to accommodate higher sales.
Remember that the aggressive revenue situation comes at a cost. You might need to rent more storage space, pay for additional staff, outsource more accounting tasks, incur more travel expenses or add new technology. However, just because a forecast is aggressive doesn’t mean it’s unrealistic. Make sure you ensure the new expenditures are needed.
Crafting an annual forecast takes time, but you’ll find it very useful when changing events during the year impact your best-laid plans.