When you’re deciding whether to recruit, purchase equipment or take on another contract, you need to understand what that commitment could mean for your finances over the coming months. Your current bank balance and recent sales figures provide part of the picture, but they won’t show every demand on your cash.
Financial forecasting brings together your financial information and assumptions about future trading to estimate your sales, costs, profit and cash flow. It can help you identify where your business could come under pressure and assess your options before you commit.
Assess whether your cash reserves are sufficient
Keeping cash in reserve gives your business some protection, but deciding how much to retain requires an understanding of your commitments and exposure to risk. A reserve that’s sufficient when trading is steady may offer less protection once you’ve increased staffing or taken on additional premises.
Financial forecasting helps you assess how long your available cash could support the business if receipts fell, taking account of which costs would continue and which you could reduce. You can then set a minimum cash balance that reflects your circumstances and monitor your forecast cash balances against it.
Understand your break-even point
Your forecast may show a profit at the sales levels you expect, but how far could your sales fall before that changes? Financial forecasting can help you assess your break-even point, the revenue needed to cover your costs.
By modelling changes in sales volumes, selling prices and costs, you can identify the point at which you’d start making a loss. If you operate with substantial fixed costs, a fall in sales may leave you with limited scope to reduce your expenditure in the short term.
Understanding that threshold can help you judge whether your plan provides a sufficient margin of safety. If a small reduction in sales would push you into a loss, you can assess whether any changes to pricing or your cost structure would provide more protection.
Use scenario planning to assess financial risk
Your forecast may show that your plans are affordable, but that assessment depends on assumptions about your sales, costs and the timing of any payments. Scenario planning can help you test how changes to those assumptions could affect your finances.
As part of your business planning, you can model the effects of a major customer reducing their orders or paying late, or a project starting later than planned after you’ve committed to staff or equipment.
You can also assess changes together. A delay in customer payments may be manageable on its own but create a funding gap if it coincides with lower sales.
You can use the results to set conditions for expenditure. If recruitment would leave you dependent on winning a particular contract, you could make the appointment conditional on securing that work.
Compare the financial risks of borrowing options
The lowest monthly repayment doesn’t necessarily make a loan the best fit for your business. A longer term may reduce each instalment but increase the total interest paid, while a loan with a final lump-sum repayment leaves you with a larger obligation at the end.
Cash flow forecasting helps you compare when those payments fall due and how you’d fund them. If you’d need to refinance to cover the final repayment, you can identify that dependency before accepting the terms. You can then discuss alternatives with the lender rather than assume replacement finance will be available when you need it.
Review your forecasts before committing to expenditure
Comparing your forecast with your actual results can help you identify when the financial basis for a decision has changed. If you’d planned an equipment purchase on the strength of expected sales, for example, a shortfall in orders could affect whether you can still afford it.
Before proceeding, you can update the forecast using your latest order book, costs and expected receipts. This will help you assess whether the purchase would leave sufficient cash for existing commitments or take your reserves below the minimum balance you’ve set.
Reviewing the updated forecast before paying a deposit or signing a finance agreement can give you an opportunity to defer or scale back the purchase if necessary.
How can Sysum Howard Duggan help with financial forecasting?
At Sysum Howard Duggan, we can help you understand what your financial forecasts mean for your business and the decisions you’re considering. We’ll work with you to assess your plans, challenge assumptions and identify potential pressure on your profit and cash flow.
Whether you’re planning an investment or reviewing your funding needs, get in touch with our team to discuss how financial forecasting could support your business.