James Pinchbeck, partner at Streets Chartered Accountants, offers tips for mastering financial forecasting for founders and entrepreneurs.
Financial forecasting can often feel like the weather forecast, financial predictions not always being as rosy as planned, or in many cases, as hoped – a bit like the weather, whilst sunshine is predicted rain all too often can be the outcome.
Whilst many businesses will look to use financial forecasting as part of their day-to-day management, there are also many who only produce financial forecasts based on need, say for external finance or investment. Certainly, those routinely producing forecasts can and do tend to benefit from having validity and accuracy with greater assurance around the numbers and the assumption used to produce them. They are also likely to be subjected to more review, check and challenge helping to improve their rigour over time.
The challenge in terms of effective financial forecasting it seems is more so with those looking to produce ad hoc forecasts. Often this can be the early start-up or scale up businesses looking for capital or investment to take it to the next stage. Few founders or entrepreneurs looking for funding are likely to be a qualified accountant or have the prerequisite skills or experience to produce financial forecasts.
Therefore, when preparing financial forecasts to seek or obtain financing, entrepreneurs and business owners often make several common mistakes. These can undermine their credibility with lenders or investors and reduce the chances of securing the needed funds. Here are some of the most common mistakes to avoid:
1. Overly Optimistic Revenue Projections
One of the most common mistakes is projecting unrealistically high sales or revenue figures. Entrepreneurs may be overly optimistic about their growth potential, leading to inflated forecasts.
2. Underestimating Expenses
Underestimating operational costs, including operating expenses, cost of goods sold, and unexpected expenses can result in cash flow problems.
3. Ignoring Seasonality and Cyclicality
Failing to account for seasonality or cyclicality in your business can lead to inaccuracies in your forecasts.
4. Lack of Detail
Some entrepreneurs provide vague or incomplete financial forecasts, omitting crucial details that would help lenders or investors understand their assumptions.
5. Inconsistent Projections
Inconsistencies between different parts of your financial forecast, such as a mismatch between revenue growth and expense growth, can raise doubts about the accuracy of your projections.
6. Not Adequately Addressing Risk
Failing to acknowledge potential risks and uncertainties in your business plan can erode investor or lender confidence.
7. Neglecting Working Capital Needs
Overlooking the working capital requirements necessary to support growth can lead to cash flow shortages.
8. Not Demonstrating Financial Expertise
Lenders and investors want to see that you understand your financials. Failing to demonstrate financial literacy can undermine confidence.
9. Overlooking Debt Serviceability
When taking on debt, entrepreneurs may not account for the interest and principal payments in their forecasts.
10. Ignoring Feedback
Entrepreneurs sometimes resist feedback from financial professionals, investors, or lenders, leading to missed opportunities for improvement.
By avoiding these common mistakes and presenting well-researched, realistic financial forecasts, entrepreneurs can enhance their credibility and increase their chances of successfully obtaining financing. As you might expect the support of an accountant is often a real asset, not least that it provides increased assurance to potential lenders or investors.
See this column in the March issue of East Midlands Business Link Magazine here.
