Forecasting Techniques for Small Businesses

Forecasting is a key tool used for business and becomes increasingly important as the business grows. Business owners should consider the following forecasting techniques:

-Develop a mix between short term and long term forecasting. Short term forecasts tend to span 12 months or less. Long term forecast are normally for more than 3 years.

-Budgets must be update and reforecast. It is important that management are provided with up to date information. Some budgets tend to be out of date by the time they are approved! Prepare monthly and rolling forecasts.

-Business projections are unlikely to be reliable over the long term. Management need to focus on the high level plans for the business and consider planning for different scenarios. Sophisticated techniques include ranged forecasting designed to address a range of potential possibilities and outcomes.

-Cash flow forecasting can take place regularly, often daily or weekly. A daily cash flow can be used to manage the day to day running of the business and to facilitate working capital management including the timing of drawdowns etc. Management also need to consider liquidity including information regarding the cash that is available within 30 days. The cash flow requires up to date information on receipts and payments of the business. It is important to actualise the data and keep the daily cash flow forecast up to date.

-Short to medium term cash forecasting takes place between 1 to 18 months. The information will be based on the latest budgets / forecasts. Management may consider monthly phasing although this can be time consuming may not be worthwhile investing the time, particularly in a group with a number of operating companies. The group finance team will often have to double check the forecasts presented by the operating units. If these are wrong it will affect the drawdowns implicit in the forecasts.

-Be aware of budget limitations. Poorly designed budgets can hide the good news for fear of stretching targets. They can also provide unrealistic expectation for turnover in the form of easy targets. Budgets can allow people to negotiate targets down to the lowest level. Alternately, expenses can be too high as they may be needed next year. Strong management will be aware of and can address the budget limitations.

-The budget process can promote a Silo mentality for companies within the group. It is important that the business strategy and associated budget will benefit the Group as a whole. A common mistake is to base KPI’s and related bonuses on the performance of individual business units rather than of the organisation as a whole. The business unit budgets must be challenged by head office management in order to ensure they conform to Group strategy.

-Regular forecasting will provide management with up to date information. It will also enable inappropriate assumptions in the budget to be addressed in a timely manner. Regular reforecasting is desirable but businesses must be careful not to lose track of the original targets and underlying performance. It is important to recognise that budgets are essentially targets whereby forecasts enable us to track our performance and assess whether we can meet these objectives.

-Management must be aware of the limitations of the businesses IT systems. Rubbish in can result in rubbish out. It is important to monitor what is being input into the system and to understand how the numbers are made up.

-Need to encourage the sharing of knowledge between departments and break down potential barriers. This will enable better forecasting. Participants must be frank and honest in the process.

-Consider seasonality of the business when assessing results.

-Forecasts bust be reviewed in line with any financial covenants.

-Capital projects must be given the same level of scrutiny as revenue spend. This is often overlooked on the budget.