Although many entrepreneurs feel like the time could be better spent on running and developing businesses, forecasts are a necessity. As an entrepreneur, you need estimates to attract investors. Importantly, they are useful in the development of long-term strategic plans. However, unless these estimates are fairly accurate, they are not helpful. Inaccurate forecasts result in mismanaged expenses, upset investors, and the possibility of running out of cash. Here are seven tips to help small businesses make accurate estimates.
1. Start with expenses
It is much easier to predict business expenses than revenues. Therefore, forecast model begins by outlining fixed expenses such as utilities, rent, and insurance. A small business can be almost sure that these expenditures will occur in the future. From there, consider recurrent expenses that fluctuate as revenue changes. For example, if revenues grow by 10%, you can probably expect the cost of sales to increase by a similar margin. In this case, there will be fluctuations in the expenses. However, these fluctuations should mirror revenue to a good degree.
Finally, entrepreneurs should be able to forecast the expenses over which they have the most control. They should be able to identify which discretionary costs can be slashed during the economic downturn. Also, they need to identify possible investment opportunities if they exceed expectations.
2. Compare multiple scenarios
When forecasting growth, most entrepreneurs tend to be optimistic. As a result, they end up using conservative projections. In reality, neither is it the only way to forecast business growth. Small businesses should base their prediction on at least two scenarios, one cautious and another optimistic. They should devote their predictive energy to at least two scenarios, especially if there is uncertainty surrounding the business environment such as competition, economic growth, and government regulations. Although it may be frustrating to compare multiple scenarios, it helps maintain flexibility during strategic planning. Also, it helps in the creation of more realistic expectations for investors.
3. Identify assumptions
Any forecast model requires small businesses to make assumptions about factors that are outside their control. These assumptions include how much will the market grow or shrink, technological advancement, and the level of competition. The best way to manage forecast assumptions is to avoid subconscious bias by listing them down. If your assumptions include ratios that improve by over 10%, it means you are too optimistic. The same applies when your forecasts are significantly superior to the competitors in the industry.
4. Outline your sales process
Instead of guessing at a top-line number, small businesses should project their revenue through the entire sales channel. They should create projections for each step involved in the sales process and use that to predict their future growth.
As an example, the revenue forecast for a fashion store might include the following steps:
i) Identify the addressable market.
ii) Projection of what percentage can be reached through marketing efforts.
iii) Estimation of what percentage of the target demographic is exposed to the marketing efforts.
iv) Projection of what percentage of potential customers will make a purchase.
v) Estimation of the average expenditure of people that make a purchase.
5. Compare and contrast
Small businesses should always assess the plausibility of their projections by comparing their forecasts to the results of comparable companies. For some ventures, it may not be easy to find data on comparable businesses. In such a case, they can compare their forecasts to their operating history. Consider certain key factors such as revenue per retailer, gross margin, and headcounts per customer. Although these ratios are not fixed, they rarely make a significant change.
6. Avoid complications
A business forecasting model does not have to be a hyper-complicated process. It should not involve high-level projections and computations. In fact, most small businesses are not sophisticated; therefore, they do not have a team of statisticians. They use simple, specific applications and software to forecast their sales.
7. Carry out a constant assessment
Forecasting should not be static. Therefore, regularly evaluate how your projections mirror your operating results. The more updated your projections are, the better prepared you will be in the future. As you become adept to forecasting business trends, you will be able to make more informed strategic decisions.