Understanding Financial Forecasting For a Startup

Running a startup often feels like a guessing game. With an uncertain economy, lingering supply chain issues, and ever-changing trends, you might feel like planning for your business’s future is a shot in the dark. You don’t need a crystal ball to look into your business’s financial future. Instead, financial forecasting can help.

Financial forecasting is a practice to help business owners assess their current situation, identify trends, and shape strategies. Unlike budgeting, financial forecasting looks toward the future — it lets you see where you’re headed and plan accordingly.

This guide will go through what financial forecasting is. We'll also cover a few tools, tips, and metrics to help you create your own financial projections, no matter what stage your startup is in. When done correctly, financial forecasting will optimize your decision-making and set your business up for stable, long-term growth.

What is financial forecasting?

Financial forecasting is the process of using historical and current data to create reliable predictions. There are several financial forecasting methods startup owners use to make forecast models, analyze market conditions, and plan for various financial outcomes.

It might sound high-tech, but financial forecasting is nothing new. Businesses have been analyzing their finances to make future predictions since the early 20^th century. Today, accounting software and other tools make financial forecasting more accurate — and more accessible. You don’t need a fully-staffed finance department to create models and plan for future outcomes.

That accessibility means financial forecasting has become the norm for startups of all sizes. Learning about financial forecasting methods and predictive analytics can help you stay ahead of the curve in your industry.  

The importance of financial forecasting

Around 44% of startup failures in 2022 were caused by the business running out of cash. Starting a business in any industry is a tremendous undertaking, and there are plenty of factors outside of your control. You can’t avoid those factors, but you can prepare for them.

Financial forecasting goes beyond standard budgeting by predicting external factors like economic changes and industry trends. It helps you craft a more resilient budget and shape your growth strategies to stay ahead of the competition. While there is no way to predict every financial surprise coming your way, effective forecasting can reduce the impact of those surprises.

Think of it this way: If your business is a car, financial forecasting is the shocks. It’s a tool to absorb the bumps in the road so you can keep driving.

Types of financial forecasts

Financial forecasting is not a set-in-stone process. It will look a little different for businesses in every industry. Ideally, you should be using a combination of forecasting tools and methods to create a clear picture of your business’s finance future.

Here are a few common types of financial forecasts that might work for your business.

Short-term vs. long-term financial forecasts

Effective forecasting looks into both your short-term and long-term future:

• Short-term forecasts account for the next 12 months, helping you shape immediate budgets and marketing strategies.
• Long-term forecasts look beyond the coming year to predict larger economic trends, revenue growth, and potential challenges.

While it might be tempting to focus on the short-term future of your startup, it’s important to prepare for long-term challenges as well. A long-term forecast helps you predict potential credit risks and cash flow issues. It also provides attractive models for potential investors.

Rolling vs. static forecasts

A static forecast, or static budget, is a fixed plan that doesn’t grow and change with your business. Static forecasts focus on a fixed time period. For example, a traditional 12-month budget that covers your routine business spending, not accounting for unexpected changes, is a static forecast.

Rolling forecasts offer more flexibility. These forecasts are updated throughout the year and account for seasonal changes, economic trends, and other external factors. While static budgets work for some established businesses, a rolling forecast can create more stability for a startup, especially in an unpredictable industry.

Sales forecast vs. cash flow forecast

As your startup’s financing changes, you’ll want to predict your future revenue as well as your cash flow. To do so, you can use the following:

• Sales forecasts predict how your sales will grow over time, considering your marketing efforts and external factors. Sales forecasts are great for scenario planning. They show how your sales will increase or decrease based on certain decisions.
• Cash flow forecasts analyze the future cash flow in and out of your business, accounting for future spending, paying back lenders, material costs, and more.

While sales forecasts are great for shaping your strategies, cash flow forecasting is important for a data-driven, informed budgeting process.

Benefits of financial forecasting

Although it takes a bit more time and research than traditional budgeting, financial forecasting can be a huge asset to your business. It gives your management team the valuable data they need to grow your business. It also takes the guesswork out of strategic processes.

Here are a few concrete examples of how financial forecasting will benefit your business.

Decision-making

In the early days of startup growth, informed decision-making is everything. Different stakeholders will have different ideas about when and how to invest, but unified decision-making is critical to growth and efficiency.

Financial forecasting provides a solid ground for decision-makers to stand on. For example, say you own a clothing brand and are considering investing in a new line of hats. You may have room in your budget for the investment, but that information alone doesn’t tell you how the hats will sell, how your brand will be impacted, and whether that money would be better spent somewhere else.

Instead of gambling on the hats, use the tools in your arsenal. Run a budget forecast, create financial models, and analyze independent variables like clothing trends to make an informed decision.

Realistic goals

It’s easy to get carried away as your business starts to grow. Financial forecasting allows you to set realistic goals for your business’s growth. In turn, that can prevent you from over-investing or burning through your funding too quickly.

A simple financial projection lets you set realistic goals such as:

• A timeline for opening a new branch or storefront
• A sustainable repayment plan for investors
• When to hire new team members
• When to expect personal income increases

Because financial forecasting provides grounded data about your business’s growth, it guides your team to collaborate on important milestones.

Cash flow management

Cash flow statements are critical components of financial forecasting. Managing your cash flow goes beyond budget vs. actuals. You also have to prepare for unexpected changes and plan for the long term. With accurate forecasts, you’ll see how certain decisions or external factors might impact your cash flow.

Investment attraction

Potential investors don’t want empty promises. They want to see real, data-backed evidence that your business is a worthwhile investment. That’s where financial forecasting comes in.

Create business projections to show your investors what your business will look like in the coming years. Projections demonstrate your future financial performance and offer a realistic timeline for payouts. Financial forecasting software creates clear, intuitive models to use as visual aids when presenting to investors.

Beyond that, detailed financial forecasting shows a potential investor that you have the tools to manage your business’s finances and that you’re serious about your long-term growth.

Business growth and expansion

Financial forecasting alone will not grow your business. However, it will give you the vital insights you need to track your business’s growth and make realistic business plans for expansion.

Forecasting can also identify obstacles to your growth. A revenue forecast will show potential drops in your revenue under various circumstances, such as a failed project, to help you avoid those obstacles. That’s why it’s important to consistently run forecasts throughout the financial year and compare forecasts across multiple scenarios.

The role of financial forecasting in different business decisions

Every business’s decision-making process is unique. While financial forecasting can’t predict everything, it does provide real-world data to guide your decision-making.

Here are a few channels where you can put financial forecasting to use.

Finance and accounting

As discussed, forecasts and projections will help shape your budget by helping you spot potential problems and set realistic timelines for growth.

Revenue forecasting is a specific financial forecasting practice that analyzes your revenue in the coming months, quarter, or year. Accurate revenue forecasts help your finance and accounting departments make crucial decisions. Staffing is a great example — an analysis of your predicted revenue supports strategic hiring so you can avoid under or over-staffing.

Marketing and sales

When planned strategically, marketing is an investment in your business’s growth. However, a poorly planned marketing campaign can be a disastrous expense. Marketing forecasts look into historical trends, your target market, seasonal changes, and your budget to predict the success of certain marketing strategies.

Operations and supply Chain

In 2021, around 61% of small businesses were impacted by supply chain disruptions. Financial forecasts can’t predict the next global pandemic, but they can predict seasonal supply chain issues, price hikes, and variable costs based on historical data. With accurate predictions, you can plan your ordering, staffing, and other operations to avoid disruptions.

Best practices in financial forecasting

Financial forecasting is an invaluable tool for your startup — if it’s done correctly. Unfortunately, misleading data and over-reliance on forecasts are common in new businesses. Here are a few tips to create accurate, productive financial forecasts that will guide your decision-making.

1. Gather accurate data

Accurate forecasts start with accurate data. Your financial statements, balance sheets, income statements, and payroll history are all vital components of a successful business forecast. If you don’t use accounting software to keep track of your financial data, make sure you’re storing it in a secure, accessible location like a cloud-based file so you can incorporate it into forecasts throughout the year.

2. Use forecasting tools

Financial forecasting software removes the risk of human error in your forecasts. AI forecasting tools create faster, more accurate forecasts than traditional methods. They can pull data from multiple sources simultaneously and create intuitive models for you.

Forecasting software may be included with your accounting software, or you can buy it as a separate service. If you aren’t using a software program, consider bringing in an expert with experience in the quantitative methods used for forecasting, such as linear regression analysis. Inaccurate calculations will produce misleading and potentially harmful data.

3. Use scenario planning

You can use financial forecasts for realistic or hypothetical predictions. Use your forecasting tools to create forecasts for various scenarios. For example, how does your revenue forecast change if you increase hiring by 10% this year? How much of a sales increase can you expect if you invest X amount into a certain marketing strategy?

With the right tools, scenario planning is fast and easy. It can be a fun way to explore new strategies for your growing business and avoid costly mistakes.

4. Involve key stakeholders

Involve all your business leaders in the forecasting process. Unified decision-making relies on hard data — that's because your stakeholders might want to see how forecasts are made. Objective data can also provide insights you might have missed for a more accurate picture.

5. Update your forecasts regularly

It’s important to not rely too heavily on a single forecast. Update your forecasts regularly and compare forecasts across different scenarios using a variety of methods. Throughout the financial year, new data will produce new projections.

Remember that forecasting is not a perfect science. It won’t show you an exact picture of your business’s future every time. That’s why you should use all the data available to you, run multiple forecasts throughout the year, and examine multiple scenarios to gather as much insight as possible.

Future-proof your financial planning strategies

Accurate forecasts give you a glimpse into your startup’s future, helping you make informed decisions. They provide grounded data to unify stakeholders, attract investors, shape budgets, and plan investments. However, inaccurate forecasts can be misleading. Make sure you’re using multiple forecasting methods and taking advantage of AI-powered forecasting software for the most accurate results.

With the right tool, financial forecasting will future-proof your decision-making.