Financial forecasting is one of the many tools needed in order to build a successful company, however many business owners neglect to complete this very important task, which usually leads to their demise.

Financial forecasting is nothing more then logically projecting the financial performance and condition of a company under different scenarios. Forecasting allows business owners to better prepare for different results that may arise from the changes within the economy, their industry and/or their business operations.

Given the current state of the economy, including, increased inflation rates, decelerated economic growth levels, tightened credit policies, and declines in consumer confidence it is advantageous for business owners to create and manage their financial forecasts in order to prepare for possible contractions and/or opportunities in their businesses.

Financial forecasting begins with formulating realistic assumptions for the key business variables that drive businesses. Depending on the type of business you operate, your key business variables will be different, however, some of the general ones are:
o Sales/Revenue
o Gross profit margin
o Selling, General and Administrative expenses (SG&A)
o Inventory days on hand
o Accounts receivable days on hand
o Accounts payable days on hand
o Capital expenditures

In determining your assumptions, you want to make sure that they are logical, defensible and reasonable, meaning that projection scenarios must be supported by current information on industry trends, recent company financial performance, management strategy and other factors which are likely to influence the future direction of the company such as competition, barriers to entry, and changes in consumer preferences.

Some of the questions that business owners should ask in determining their assumptions are:
1) Given the increase in oil prices, how will that affect my operating costs over the next 12 months?
2) Given the decline in consumer confidence, how will that impact my sales levels for the upcoming holiday season?
3) How will the tightening of the credit market have an affect on my ability to access credit?
4) How can I take advantage of the low interest rate environment?

Upon determining your key business variables and plunging them into your financial model, a full financial analysis should be conducted on the financial results. How will the changes to your key business variables affect your cash flow levels and your ability to cover your fixed expenses? How will it affect your financing needs?

Based on the answers to the above questions and others, the business owner should develop a plan of attack in order to mitigate their risks and take advantage of opportunities.

It is important that business owners formulate several financial forecasts (best case, worst case, break even case) and review and alter them on a monthly basis. By doing so, the business owner will be at a better position to prepare for different outcomes and have greater levels of control over the direction of their company.