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Forecasting

Forecasting is part art and part science. Art because it’s going to be about the CEOs feel for the business, its market and customers. Science because there are certain predefined financials that have to be taken into account.


Building initial forecasts with any degree of accuracy takes a lot of time but is time invested wisely. First, proper financial forecasts will help you develop operational and staffing plans that will help make your business a success. Second, few investors will put money in your business if you’re unable to provide a set of forecasts with your plan. When building a financial forecast for a business that’s at pre revenue or early revenue stage it’s hard to forecast against those things over which you have limited control such, so start with something you do have control over, costs and expenses. Begin with estimates for the most common categories of expenses as follows:

Fixed overheads:

  • Rent
  • Utility bills
  • Phone bills/communication costs
  • Accounting/bookkeeping
  • Legal/insurance/licensing fees
  • Postage
  • Technology
  • Advertising & marketing
  • Salaries

Variable Costs

  • Cost of Goods Sold
  • Materials and supplies
  • Packaging
  • Direct Labor Costs
  • Customer service
  • Direct sales
  • Direct marketing

When forecasting expenses remember:

  • Your estimates for advertising and marketing will always escalate beyond expectations.
  • Legals, insurance etc are hard to predict without experience and almost always exceed expectations.
  • Keep track of direct sales and customer service time as a direct labour expense even during the startup stage because you’ll want to forecast this expense accurately when you have more clients.

Revenue scenario planning

It’s common practice to do two sets of scenarios.

Realistic: A realistic target i.e. what the business needs to generate shareholder value. It’s normally the target that underpins the finances and justifies costs and overheads.

Stretch: A stretch target is also worthwhile – that’s having a great year or quarter where everything forecasted to drop comes in on time and at the forecasted price point.

If this scenario can be supported by the realistic overhead and expenses plan, it augurs well for the scalability of the business. However additional overhead should be planned for additional sales people or customer service reps or materials.

By unleashing the power of thinking big and creating this set of ambitious forecasts, you’re more likely to generate the breakthrough ideas that will grow your business.

Fail to plan, plan to fail

By building these sets of projections, you’ll force yourself to make conservative assumptions and then relax some of these assumptions for your aggressive case. Many entrepreneurs will optimistically focus on reaching revenue goals and assume the expenses can be adjusted to accommodate reality if revenue doesn’t materialize. The best way to reconcile revenue and expense projections is by a series of reality checks for key ratios. Here are a few ratios that should help guide your thinking:

Gross margin. What’s the ratio of total direct costs to total revenue during a given quarter or given year? Beware of assumptions that make your gross margin increase from 10 to 50 percent!

Operating profit margin. What’s the ratio of total operating costs-direct costs and overheard, excluding financing costs-to total revenue during a given quarter or given year? As revenues grow, overhead costs should represent a small proportion of total costs and operating profit margin should improve.

Headcount per client. Divide the number of employees at your company by the total number of clients you have. When does the productivity of your workforce kick in to be able to make step growth with new customers without adding additional staff? If you have to forecast then forecast every day. You don’t have to spend hours on this vital planning if the work is done up front. The more you understand the numbers, the more you understand the business.

 

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