Financial Forecast

Why Forecast?

Your financial statements indicate past performance.  This information will certainly interest potential investors.  What's more important, they will look to your company's projected financial statements to see whether your business is a good investment and one that will generate a return on their investment.

What is Financial Forecasting?

Financial forecasting involves making a set of financial projections that will provide the figures to help to quantify the goals, descriptions and other information in your Business Plan.  You need to provide detailed forecasts for at least the first 12 months of your operations.
Your investment proposal must include forecasts that show how your company will operate as it grows.  Once you know your current financial situation and have defined your vision – by setting your growth objectives and producing a Business Plan, then you can start projecting your financial needs.
When preparing your financial forecast, you will need to consider:

• The capital you will need from external sources.
• The security you can offer any lenders.
• When you can repay lenders and what repayment option is the best.
• Your specific sources of revenue and income.

Cash Flow Statements

Cash flow statements provide examples of pre-business costs, capital costs, initial costs plus operational or overhead costs and how these costs feed into an estimation of whether your cash reserves will be enough to cover the first 12 months of operation.

As part of your financial forecasting, you will need to prepare a simple cash flow forecast covering the period from pre-establishment.  These monthly cash flow figures will help you to estimate the net outflow of cash that you will need each month up to the point at which the business begins turning a profit.

Remember that preparing cash flows will require an estimate of the level of sales on a month-by-month basis.  To make accurate estimates and calculate the total funds required for your business reliably, you require good Market Research or industry experience.

Making Reliable Financial Forecasts

Trust is something that is earned, not given.  You have to build a relationship with investors, even before they invest in your business.  You do this by presenting reasonable and credible forecasts and showing that you understand and are comfortable with your forecasts.
Financial forecasting must be based on your company's vision, moderated by the experience and insight of your management team and your forecasts must be supported by reasonable assumptions.
Here is an overview of the process:

• Review your past operating results.
• Analyse expected future market conditions for your various products or services.
• Estimate your future sales volume, price and revenue for each product.
• Estimate future costs based on forecast sales volume and expected cost relationships.
• Deduct income taxes.
• Make accounting adjustments, such as depreciation and amortization.
• Deduct what you expect you will spend on fixed assets, working capital and financing.
• Include the proposed investments in the forecast.

Make Your Assumptions Reasonable and Explicit

The assumptions used to prepare your projected financial statements must be stated clearly, reasonably and consistently.  Be sure that:

• The working capital needs, production capacity and personnel requirements you predict are consistent with the level of growth you forecast;
• The growth rate you forecast is reasonable for the market you are in; and
• You can really achieve any gains in market share that you forecast

How to Make Reliable Financial Forecasts

Two key financial statements in the forecasting process are the cash flow forecast and the statement of changes in financial position.  Here's what you do.

1. Review Past Operating Results

Determine:

• Past sales growth rates by product;
• Cost relationships to distinguish among fixed variable costs;
• Items of income and expenses that are unusual, non-recurring or not indicative of expected results;
  
• Income derived from assets that may not be included in the company during the forecast period (i.e. non-operating assets that may be withdrawn from the company before completion of the investment, such as excess cash balances, investment portfolios, art or excess land); and
• Break-even volume for any new product line.

2. Make Estimations

• Estimate sales volume, price and revenue for each product, monthly for the first year and annually, thereafter, for years two, three, four and five based on an analysis of future market conditions for your various products.
• Estimate costs for each future period based on forecast sales volume and expected cost relationships.  Additional fixed and variable costs associated with forecast growth should be included in the estimates.

3. Make Deductions

• Deduct income taxes based on projected tax rates.
  
  If there are significant differences between expenses recorded for accounting and for tax purposes, you may want to make these adjustments in a separate calculation.  The primary adjustment would relate to the difference between depreciation recorded for accounting purposes and capital cost allowance recorded for tax purposes.  Also, consider the impact of tax losses carried forward.

4. Make Adjustments

• Adjust net income to cash flow from operations by adding back all non-cash charges included in the determination of net income.  The main non-cash items are depreciation and amortization.
• Based on your forecast operating cash flow, deduct the following:
• Forecast capital spending based on the capital budget;
• Increase in working capital required to meet the forecast growth in operations;
• Dividends consistent with prospective dividend requirements; and
• Interest payments consistent with existing and proposed lending agreements.
• Add cash inflows not included in cash flow from operations such as interest and proceeds from the sale of assets.

5. Include Proposed Investments

• Finally, include the proposed investments in the forecast.