Whenever you drive for camping you ensure to pack the tent, sleeping bags, and pads, camping pillow, flashlights, and put an extra gas tank in the hood among multiple other things – You follow a camping checklist. Just as you prepare for your trip beforehand, you need to do financial preparations for your small business as well – financial forecasting. Despite an impeccable business plan, a business might need external help from a business loan to manage the cash flow. In that case, banks, credit unions, and alternative lenders look at the financial forecast of the borrowers. Predicting a financial future is challenging but with the right information, you can take some steps in the right direction.
What is a financial forecast?
In simple terms, financial forecasting comprises of numerous financial statements often labeled as pro forma statements. Lenders, banks and angel investors consider this essential financial information when they are working on a business loan deal with you. An ideal financial plan consists of an income statement, a CFS (cash flow statement), and a pro forma balance sheet. A business manager and the borrower must work on these financial documents in the order.
Income statement: This mentions the amount of money that comes in and goes out of your business.
CFS: This uses the data from the income statement to predict profit and loss.
Pro Forma Balance Sheet: This uses the data from income statement and CFS to forecast assets, liabilities, and equity.
Once you have all the data, you can assess the financial position of your business. Financial forecasting is different from the bookkeeping; bookkeeping sheds light on what you owned and spent in the past. Financial planning and forecasting are about what will happen in the future.
What is the importance of Financial Forecasting?
For a business owner, it is important to formulate a business plan to stay ahead of the financial surprises. A financial business plan is a window to the financial indicators integral to the growth of the small business. Ideally, a small business owner should make a business plan for at least 6 months to a year.
It sounds tiring at first, but as most of the lender ask for a two to three-year business loan, so make sure you have the financial data dating back to the two to three years. It is wise to make a business plan beforehand, to keep yourself ahead of the financial problems. At the time of the financial crisis, the focus should be on the perfect funding rather than getting preparing all the required documents.
What does your income statement depict?
As the data for the pro forma balance sheet and cash flow statements come from the income statements, you must understand income statements from every angle. The primary purpose of the income statement is to compare your assets to the expenses.
Start by listing all the potential expenses of your small business loans for the next years to come. Know the difference between the operating expenses and the total cost of the sales. Cost of sales includes all the expenses related to your product or service. Common operating expenses include marketing advertising and rent. On the other hand, the cost of the goods includes the total cost of the material that is necessary for your small business.
Project and introspect your sales
By looking at the daily and monthly sales, you can predict the pattern of the off-season. If you see a significant increase or decrease in sales, then you must take a note of it. In addition to this, calculate the cost of the goods sold also known as COGS. Add the cost of the inventory by the start of the year with the total cost of manufacturing. Later, if you subtract the cost of the ruminant inventory, you will have the cost of the goods sold (COGS) of the remaining year.
Furthermore, if you are running a service-based business the expenses such as how much you pay your employees would come under the cost of purchases. If you have an expense that is not directly related to your service or product, make that another section and put it there.
As your income statement can predict future economic trends, so work on multiple scenarios to keep your business on the safe financial side. Create all the hypothetical scenarios, for example, if everything works in your favor, then your business can grow exceptionally. On the other hand, imagine the worst-case scenarios as well, hypothetically speaking if there is a delay in the production, so as a diligent business owner you must have a financial backup.
What does Cash Flow Statement depict?
As a business manager, you must know the difference between cash flow and profit. Running a profitable business is a plus for you, but unless you are not generating enough income and don’t have consistent cash flow, you can’t run a successful business. Take a glance at your annual revenue and expenses and draw a cash flow statement. A CFS can help you figure out the total amount of money you need from the lender. External funding is a remarkable and beneficial way to take your business on the path of success.
How to create a pro forma balance sheet and what does it depict?
Now that you know how to create and understand income and cash flow statement creating a balance sheet is a walk in the park. Use the balance sheet to foretell the financial changes in the business by comparing the company’s assets, equities, and liabilities.
Assets: one part of the balance sheet is your assets from the operating activities, investing and financing.
Liabilities: this will include all the pending debt.
Tip: The key is to make a rational and realistic plan for the future. If you are applying for a one million dollar business loan, you must have enough cash flow and a ‘fair’ credit score as well.
Reviewing is a must!
Once you are done designing and entering all the data related to the income statement, cash flow statement, and balance sheet. Make sure the final number on the sheet synchronizes with each other. For a quick assessment of these documents, enter your data in the ‘quick ratio.’ One side of the ratio will determine your cash and account receivables, and the other side of the ratio consists of all the liabilities. If the ratio comes out to be 1:1, your business is financially healthy. If the quick ratio comes out to be higher than 1, you have enough cash to invest in other projects. On the other hand, if the number is less than 1, you are running out of cash and it is an alarm to take help from the business loan.
Cheat sheet for financial forecasting
To keep you healthy and to stop the grey in your hair, we have penned down a cheat sheet that will you forecast your financial condition and will tell you whether the small business needs a business loan or not. Open the spreadsheet and you are good to go!
- Create a column for each month of the year.
- Add another row and list and add your current cash position in that row.
- Make a row titled “sources of cash” and add the relevant data.
- Next, create another row titled “complete list of sources of cash” and add the number you are starting with.
- Another row that is dedicated to the “uses of the cash.”
- Another section would be signifying the bottom line.
- Finally, take that number from the bottom line section and move it to the top row of the next month.
Now that you have the template, all you need to do is add the numbers and notice all the patterns and predict the financial growth for the future.
Once you have completed the financial forecasting, you are multiple steps closer to leveraging the financial planning and forecasting for the growth of your small business. As financial forecasting can help you assess your business loan needs. Take a look at all the small business loans offered by the Merchant Advisors, if you think your business needs external funding, then apply for a loan Rely on business loans to grow your small business not to keep it alive. For more tips and guides on a business loan, follow us on Facebook and Twitter (@Onlinecheck). If you have any questions, call us on our toll-free number at (833) 827-4412; our financial advisors will help you every step of the way.