Financial Forecasting: Understanding the Basics

Financial forecasting can help startup companies future-proof their business, especially at times of crisis. This article will cover two topics: why it’s important for companies at every stage and the basics of how to go about setting up forecasting.

Financial forecasting can help startup companies future-proof their business, especially at times of crisis. This article will cover two topics: why it’s important for companies at every stage and the basics of how to go about setting up forecasting. 

(This article is a summary of Liz Foxwell-Canning’s presentation at Startup Breakfast Club webinar on 2nd April 2020. Liz works as the Manager of Private Client Advisory at EY New Zealand. Watch Liz's video presentation below.) 

Forecasting is the process of predicting a company’s financial position in months ahead. The three primary elements of forecasting are turnover, profit and cash.

Financial forecasting isn't expected to be precise. Instead, it helps predict the short and long-term financial position of your company. It is the cornerstone that helps companies make better-informed decisions. These decisions can be, for example, whether to hire a new role, whether to target a new market, or whether to raise more capital.

For both bootstrapped startups (who haven’t raised VC money and not planning to do so) and VC-backed startups, it’s important to know your burn rate. This is the rate at which a company spends its capital. For example, if you have $10,000 in the bank on day 1 and $4000 left after 3 months, then your burn rate is $2000 per month. This helps you calculate your runway - how long your startup will survive before running out of capital.

Businesses forecast differently from sector to sector. For example, a software-as-a-service business can have revenues coming in quickly and consistently. Whereas, an R&D company that’s building a product from scratch, which requires more upfront capital, will take longer to generate revenues. Businesses like dairies or cafes often need a large upfront investment in stock. Tourism operators need to forecast the peaks and troughs of when the money’s coming in depending on times of the year. Overall, the diverse needs of various businesses means few forecasts will be the same. 

Things you need to consider when setting up forecasting

  • Separate different products and services that you sell to work out how much margin for each product/service. 

  • Think about how and when you pay your suppliers ie. upfront, on delivery, after having received your products.

  • Think about how and when your customers pay you ie. when they make an order, monthly basis, etc.

It is important to understand what you’re spending to support your business vs when the money arrives in your bank account because the time delay between these two events is massively impactful on your cash flow. The longer the delay, the more severe your cash flow is affected, and the less cash you have in your bank account (if supplier payment delay is shorter than client payment delay).

Other factors to take into account when setting up forecasting are,

1) your overhead costs ie. rent, stationery, marketing costs, travelling, insurance, etc. And, 

2) taxes ie. GST, income tax. Remember to take into consideration when these payments occur. 

Scenario analysis

Amid the uncertainty of the current lockdown situation, it’s important that you play around with different scenarios ie. what your financial situation would look like if we are in lockdown for 4 weeks, 6 weeks, 12 weeks, or longer; what if the NZ border doesn't open again until next year? etc. When forecasting, it helps to plan out multiple scenarios. For example, write out optimistic, realistic, and pessimistic forecasts. 

Overall, building out a clear picture of your company’s financial state is critical as it gives you an indication of how your company will perform. It also influences the decisions you make in both short and long term to ensure the success of your business. 

Tools for financial forecasting

  1. Futrli 

Futrli is an online tool that helps quickly run multiple, complex sets of scenarios and assess impact on cash flow. It plugs directly into Xero, allowing for adjustments on variables for each scenario and produces PDF reports that can be shared with the board, investors, and your leadership team.

  1. MYOB

MYOB is an accounting software that can also help in regards to managing money in and out, you can build cash flow forecasts, budgets and of course have a clear sight of P&Ls.  For start-ups, there's also special pricing of just $5p/m (businesses less than 2 years old). You can take a free trial on myob.com to check it out.

  1. EY Finance Navigator 

EY Finance Navigator can help startups to assess the financial impact of COVID-19 on their companies. They are offering three months of free access. You can check it out here