Past performance evaluation is an essential part of accounting. The financial results of a business demonstrate its success to owners and stakeholders. While looking back to demonstrate success, it is just as important to prepare and plan for the future.
Financial forecasting plays a crucial role in this process.
A financial forecast is an educated prediction or a method of estimating a business’ future financial outlook through planning. By inspecting the company’s current financial situation, it is possible to forecast its anticipated income and expenses over the following year. This process can help the organization’s management make informed decisions about budgets and plans for the year.
With forecasting, businesses can set measurable and reasonable goals based on past and recent data. By analyzing accurate information, companies can determine how much growth they would like to target.
Your forecasts can also serve as a useful reminder of where you should be at any given point in the year, allowing you to identify deviations from your plans and action accordingly. By being aware of potential trends and changes, companies can allocate their budgets and time to specific products, services, or internal efforts.
Forecasting is also a vital tool for planning your business growth. Whether it’s hiring new people, launching campaigns, or cutting costs when the business slows down, this helps you align your finances with your business plans.
Follow these steps to determine and meet your profit goals through forecasting.
Financial forecasting begins with determining a company’s financial goals. Establishing clear expectations about the business’ finances for the following month, the next quarter, and the coming year is crucial. You may aim to increase revenue, reduce debt, or add products or services to your inventory.
Ensure you plan your budget in detail. You should start by estimating how much revenue you expect to have each period. Perhaps you have recurring revenue, in addition to periodic revenue from clients who are invoiced as they purchase goods or incur services.
Then, you should identify how much you believe your company will spend over the period. Consider the fixed costs and your best estimate of variable costs, then begin to layer in other costs to support your growth plans. This might include marketing campaigns, hiring new employees or investing in new software.
As part of the process, you should also consider your business’s financing options and developing a backup plan if additional cash flow is required.
Calculating key ratios will help you align revenue and expense projections and bring you closer to your profit goal. Here are two things you should keep in mind:
Gross profit margin is a profitability metric that indicates the amount of revenue left from product sales after subtracting the cost of goods sold. This is the firm’s net profit margin before excluding selling, general, and administrative costs, giving you the forecasted gross profit.
It can be calculated using this formula:
Gross profit margin = ((Net sales – COGS) / (Net sales)) x 100%
For many businesses, such as restaurants, retailers, and goods producers, 50% to 70% gross profit margins are considered healthy. But for legal firms, financial institutions and other service industry companies, a gross profit margin of 50% is low. It’s one of those areas where aggressive assumptions tend to fail. You should be cautious if you assume your gross margin will increase from 10% to 50%.
Determining how much your target gross profit differs from last year’s is also advisable. To reconcile the difference between these two numbers, you must increase sales and productivity and improve material efficiency.
It is also a good idea to periodically calculate your gross profit margin and compare it to your competitors. This way, you can see how your business compares to similar companies and identify ways to increase profitability.
Additionally, ensure your pricing strategy and inventory management are both under control. Consider whether you want to eliminate or boost your margins for lower-performing items and boost sales of your highest-margin items.
An operating profit is a profit your business makes after deducting its total operating expenses. It is one of the quickest ways to determine how well a company manages its resources.
It is determined using the following formula:
Operating Profit Margin = (Net sales – (COGS + SG&A)) / Net sales) x 100%
Unlike the gross profit margin, which tells you if you are making money after subtracting labour, materials and other production costs, operating profit margins reveal whether you are making money after deducting rent and utilities, marketing and sales staff and administration expenses, and plant and equipment depreciation. Moreover, it allows you to compare your company with others that operate in the same industry.
Predicting the cost of goods sold (COGS) is a vital part of financial forecasting in any organization. The aim is to estimate future costs to budget for inventory, accurately predict future profits, and make other strategic decisions. With accurate COGS forecasts, businesses can ensure that their products and services are priced appropriately, and inventory is not over- or under-purchased.
You and your management team must be on the same page regarding increasing sales, improving labour productivity, and streamlining expense and supply management. It will be easier to assign specific responsibilities to individuals this way.
Make sure to check your financial forecast at least once a month. This way, you can closely monitor your progress and alter your plans if necessary. Keeping an ear open to customer and employee feedback during the year will also help to signal if changes are needed in your plans in order to reach your forecasted target.
Forecasting allows businesses to optimize resources by adjusting and adapting to future predictions. Business organizations can use many tools that assist in gathering information and provide a better understanding of how budgets support operations that allow a business to reach their future profit targets.
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This blog is not meant to provide specific advice or opinions regarding the topic(s) discussed above. Should you have a question about your specific situation, please discuss it with your GBA advisor.
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