Sigh. “I hate doing accounting paperwork”, you say.
We get it. In fact, more than half of business owners in a TD Bank survey said bookkeeping is their least-favourite task, followed closely by tasks such as handling finances and banking.
While small business accounting tasks won’t be winning any popularity contests any time soon, they are a necessary part of successfully managing your business.
Preparing a profit forecast is one such task which is vital if you want to stay on top of things. Before your eyes glaze over and you put it as yet another item in the “later” pile, there is good news. It doesn’t have to be as complicated as its name sounds. Here's how to create a profit forecast the easy way.
What Is A Profit Forecast?
Quite simply, a profit forecast is a prediction based on the financial data you have available of what your business income will be at set intervals or a set time in the future.
To create an accurate forecast, you need to have good information (or very educated guesses) of business expenses and income.
Why Do I Need One?
There are a few very good reasons to prepare up-to-date profit forecasts. Here are some:
- So you can accurately manage your spending and know what you can afford.
- So you can get on top of any forecast revenue issues early. (For example, perhaps you need to spend more on targeted marketing to bring your sales up, or perhaps you need to reassess your margins).
- So you can watch for trends in your sales. (For example, perhaps certain products you have are waning in sales, while others are growing).
- So you can plan your staffing, operations, and any thoughts of expansion.
- It helps you to recognize seasonality in your business so you can plan accordingly.
- To attract investment funds. Potential investors will ALWAYS want to see this document.
- You’ll need one if you want to apply for business lending.
What it really comes down to is having an as accurate as possible picture of the overall health of your business. Like it or not, your profit forecast is a good predictor of whether your business is going to succeed or fail. And, if the track you’re on doesn’t look good, the time to remedy it is sooner rather than later.
Steps for How to Create a Profit Forecast
Alright, there’s no more avoiding it, creating a profit forecast is an important component in your overall business arsenal. Here’s how to get started:
1.) Calculate Expenses
Expenses are usually the part you know best (as long as you’re keeping accurate track of them!). This makes them a great place to start for your forecasting.
Here’s what you will need:
These are the expenses which remain the same no matter how much you sell or what you produce. Typically, fixed expenses have very little variation from quarter to quarter.
The table below shows fixed expenses an online business may consider:
Variable ExpensesThese tend to be related to how much you produce or sell, hence the variation. Below are examples of variable expenses for an online business:
Basic Rules For Expense Forecasting
More rules you ask?! Yes, but hear us out. These are not difficult and a basic understanding will help your overall accuracy.
- Include absolutely everything business related. Missed expenses here and there can add up to a big difference across 12 months.
- Lean on the conservative side for variable expenses. That means doubling items such as marketing costs.
- If you’re a solopreneur now but have the potential to grow and hire staff, keep track of how long service-related tasks take you. You’re going to have to plan for the staffing expense to cover them.
- Review expenses regularly. Your utilities may have gone up from six months ago, for example.
- Forecasting is rarely going to be 100% accurate. But, if you choose your timeline for forecasting, average out your expenses over that time, and perhaps factor in a percentage to recognize any future increases, you can project with relative confidence over the time you need.
2.) Forecast Your Sales
Ok, this is the bit which usually causes angst and head-spinning, especially if your business is young. It’s much easier for startups to figure out expenses, but revenue tends to be a slightly ethereal quantity. However, what it really comes down to is making some logical assumptions from raw data.
- If your business has been around a little while: Look at your past sales data, then use it to guess what future sales will look like. You can factor in things like: your current growth rate in terms of customer base, market conditions and seasonal variations, any plans you have for expanding what you offer or who you offer it to.
- If you are a startup: It’s slightly trickier, but you just have to be extra-good at research. Factors to account for could include: the size of your market based on creating an ideal customer profile, estimating your share of that market, forecasting repeat business (how often will customers buy?), forecasting the average amount of each purchase.
Here are some ideas for improving the accuracy of your sales forecasts:
- It is fine to create a highly conservative forecast and a second one which reflects your “dream” state as an entrepreneur, with more aggressive predictions. Often putting these stretch ideas down on paper helps to solidify them and make them closer to reality.
- It helps current businesses if you look at your entire client pipeline (including prospects) and understand what your average conversion rates are.
- Remember, invoice is not income. Only include revenue you’ve actually been paid.
- Look at reports on recent consumer spending statistics.
- Look at statistics on your target market – is it growing, shrinking, or remaining steady?
- Look at relevant industry reports.
3.) Combine Your Figures
Once you have figures for expenses and sales, deduct projected expenses from projected sales to come up with your profit forecast.
Still not sure and need further “sense” checks? We’ve got a few tips for that too:
- Begin with monthly or quarterly forecasts if the thought of annual ones is daunting.
- Check key ratios such as gross margin and operating profit margin (both should increase over time, but if you’re predicting more than 10% in the short-term, you may want to scale back your figures to a more worse-case). Check industry profiles for averages.
- Remember, your forecasts will only make sense if you’re following a strategic plan to get you there. Any changes need to be accounted for by revisiting your profit forecast.
- If this is all too much, seek help from a qualified advisor! It’s much better to pay someone else to help you than to keep putting it off yourself.
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Possibly you’re doing the dishes, counting paperclips, or doing anything else which pops up and keeps you away from attending to financial paperwork. But no business can put this off for long.
In fact, the quicker you get onto it, the less arduous the task of profit forecasting will seem. Not only that, you help yourself out by being on top of things early.
Besides, the research part can be fun! Think of all that valuable market information you can learn and plan for in your marketing. Get started as soon as possible and revise your forecasts often to keep your business in a better position.
Note: At Quaderno we love providing helpful information and best practices about taxes, but we are not certified tax advisors. For further help, or if you are ever in doubt, please consult a professional tax advisor or the Tax Agency.