Financial statement forecasting.

What is financial forecasting?

Financial forecasting is the process of building financial projections using reasonable and accurate assumptions about your business.

While maintaining accurate accounting records is an important task, financial statements only show a picture of past transactions. These numbers generally help you understand which activities helped your business generate positive cash flows, as well as the general financial strength of your balance sheet. Financial analysis will help you understand the past, but won’t immediately help you take action to increase your bottom line. This is where the financial forecasting process comes in handy.

Also known as financial modeling, the process of forecasting your cash flow, income statement and balance sheet require in-depth understand of the financial components of a business.

The business consultants of Zen Valuations have helped a wide range of businesses, from small business to established, present accurate forecasts and take informed decisions.

Modeling a business should be part of the strategic planning activities of any business in order to track and achieve corporate objectives. A strong financial model will help the reader understand:

1.     The breakeven point;

2.     The relevant Key Performance Indicators (KPI) of your business;

3.     Benchmarking your business against the competition and industry;

4.     The risk of investing in your business;

5.     The return on investment (ROI) of your business;

6.     Making clearer and better business decisions;

7.     Whether cash flow will be available to repay debts and liabilities;

8.     The Fair Market Value of your business;

9.     Important financial ratios such as debt-to-equity and price-to-earnings;

10.  Build financial dashboards to track your business growth.

Objectives of financial forecasting

Financial forecasts can be used in many situations. Depending on the life cycle of your business, they will be needed in various scenarios.

Start-ups: Presenting a pitch deck or pitchbook to investors

When seeking investments in your business, either in the form of equity or debt, start-ups will generally need to pitch their ideas.

This is done through building a concise pitch deck. The pitch deck is a clear presentation of your business, through a deck of not more than 19 pages, that will help you attract investors. It is presented in a live session with investors.

One of the key aspects of a pitch deck, and where investors will spend most time, is the financial analysis and forecast section. This section should show the relevant KPI and financial benchmarks that tie in with your business metrics of the presentation. It should be logical and straight to the point.

A pitchbook is generally the second document that will follow the pitch deck. This is a more detailed analysis of the company and is a printed documented that is read more thoroughly. Financial forecasts will need to be bring more precision and answer the investor’s questions.

Start-ups and growth: Raise financing with financial institutions

Among other documents, the business plan will generally be needed by institutional lenders. The business plan will need to provide a clear financial modeling section, outlining positive cash flows to repay the debt. Lenders will generally make their own internal analysis of the business, but having a thorough financial projection to start with will be quicker.

The forecasts should also show the relevant financial ratios that bankers will use to assess the risk of your business. Such ratios include:

1.     Debt/equity ratio;

2.     Debt servicing ratio;

3.     Current ratio;

4.     Quick ratio;

Distressed or growth: Decision making

Decision making is hard when you do not have an accurate image of the situation. Financial modeling will showcase 3 different scenarios to help you prepare:

1.     Worst-case scenario;

2.     Status-quo;

3.     Best-case scenario.

A thorough financial model will help you assess the different assumptions about your business and prepare for the worst. A seasoned financial consultant will be a strong strategic partner that can help you decide between:

1.     Relocating your business;

2.     Opening a new location;

3.     Renovating your business;

4.     Liquidate or sell your business;

5.     Other.

Any business: Budgeting and financial planning

Budgeting is the process of forecasting your business financial statements and breaking down the relevant key performance indicators to target during the year. This process is usually done on a yearly basis, but can be done more often for a seasonal business. This is the case for fashion businesses that need to update their levels of inventory each fashion season.

Budgeting is an integral part of internal processes and is a key success factor for many business owners.

Fashion and retail business: Demand planning

Demand planning is the activity of buidling sales forecasts and revenues in order to plan for inventory. Usually, this is done at the merchandising level. Forecasting takes a huge place in demand planning activities, as the budget will set out the level of inventories required.

Once a budget forecast is established, demand planners will use these to plan for monthly levels of inventories and replenishment needed. This is usually done using an assortment plan for the different categories of inventory that the retailer is selling.

Looking for financial modeling consulting firms?

Our financial analysts have helped numerous retailers and fashion brands manage inventory efficiently. By planning ahead, gross margin per SKUs can be met with budget objectives, which ultimately will increase your bottom line.

Whether you are a start-up, in a growth phase or a mature business, our financial consultants can help you identify your business metrics and drivers. We will build the different financial scenarios and help you get a clearer picture of the situation. Our network of partners can also help once a decision is made.

Importance of forecast accuracy

As mentioned previously, the goal of financial forecasts is to benchmark your results against expected performance indicators. If the process of forecasting your financial statements is not done using accurate or reasonable assumptions, your targets will be either to high or too low. This ultimately nullifies the entire goal of a financial forecast.

When building your forecast, accurate sources of information have to be used. This can either be through market research, industry analysis or historical financial performance.

Only the most experienced professionals will be able to build accurate financial forecasts.

Levels of difficulty (Startup, Growth, Mature)

Financial forecasting grows in difficulty when the more the business or project is a new one. This is because historical data are not available. The financial analyst will therefore need other sources of data that are not readily available either. Market research and industry analysis will be key skills to have in order to build projections that make sense.

Start-ups usually have this problem when pitching to investors. Because their business model is so fresh, we expect their results to dramatically change in the future. The expected volatility of results in a start-up is a challenge for many investors.

Nonetheless, long term key metrics still have to be accounted for, such as website traffic, number of users, repeat orders, actual customers, and so forth.

How to financial forecast?

The process of financial forecasting will begin with retrieving the necessary documents. As such, financial statements for the past three years will be a starting point. These include:

1.     The income statement or P&L statement;

2.     The balance sheet; and

3.     The cash flow statement.

If we are dealing with a start-up, more work will need to be done. An interview with the founders will be mandatory to understand the business in-depth. As mentioned previously, their key metrics will also need to be analyzed and benchmarked against the market, economic and industry data.

Once long term assumptions have been confirmed, financial statements will need to be forecasted using modeling in excel. All three financial statements will need to balance out each other.

The cash flow statements will be the most relevant to investors and lenders. This is because they will want to know if your business has the necessary liquidity to pay back the debt or dividends.

A good financial model has three criteria:

1.     Dynamic: The user should be able to change assumptions and see the impact of a change on the bottom line. As well, all three financial statements should be linked together and balance out;

2.     Understandable: Assumptions need to be outlined, as well as clear KPI.

3.     Clear conclusion: The model has to answer the user’s question. This is usually done through a summary table.

Key Performance Indicators (KPI)

We have mentioned the importance of key performance indicators, but what exactly are they.

KPI are financial or non-financial metrics on relevant to your industry and which your business needs to track to build operational success.

In financial forecast, KPI will tell the reader whether results are logical or not. If you forecast sales volume for a retail store that are higher than the store’s capacity, your financial model will not be logical.

Once forecasts are built, KPI are usually summarized through a balanced scorecard dashboard. This helps the business and its operating units keep track of their performance throughout the year. The balance scorecard is also used during strategic meetings, to understand where the business is lacking success and how to remedy or capitalize on opportunities.

Our expertise: financial consultants for startups

Zen Valuations is a consulting firm with experienced management consultants that have helped multiple small to large businesses reach their financial goals with financial modeling consulting services. We distinguish ourselves from the competition by our smooth process and strategic thinking when building financial forecasts. Our strengths rely in clearly showcasing the investment opportunity to a lender and logically explaining the return on investment.

As well, the work of our business plan writers and financial forecasters has been recognized by many financial institutions. High-converting business plans means that we minimize lenders worries and questions. We make it clear that this is a good investment opportunity.

If you would like us to help you draft solid financial forecasts, feel free to contact us.