Operating a small business is like a hike in the woods where the trail is mostly familiar, but sometimes referring to a compass is key.
The entrepreneur’s compass is the financial forecast. These projections guide you in the course you want to take. And when the path twists you in a different direction, the forecast shows where you’re offtrack and how to get your bearings back.
Your forecasts allow you to set goals and milestones. More importantly, they permit you to measure progress toward your objectives. Many entrepreneurs avoid making financial forecasts because the process entails a lot of numbers, which seem cumbersome to calculate. However, forecasting can be a simple process. Use a spreadsheet to identify a few basic factors, with which you’re probably already familiar. These factors create your financial forecast.
The top line in your financial forecast is sales revenue. But determination of this figure requires an initial step of identifying your available resources. These elements are cash and time.
Cash: Assess available funds for inventory and other costs that must be paid before you collect from customers. The money on hand for these things represents a curb on how much you can sell.
Time: Your revenue is limited by the time you have to contribute to the business. Selling more than you can deliver individually means adding staff, and that brings you again to a cash need.
2. Direct Costs
Once you’ve determined your resources, start identifying direct costs. Begin with all direct costs, such as inventory or materials. Labor cost is also commonly a major direct factor in generating sales. For solo-operated service providers, the only direct cost is typically the entrepreneur’s time. The key dynamics are how much output the individual can accomplish every month and the amount of personal income desired for the effort. This owner compensation target is the major direct cost in many basic business models.
3. Sales Revenue
When your direct costs are identified, sales revenue is projected as a multiple of those expenditures. All you need is your ratio of direct costs to sales revenue. This may be calculated using historical data. Or you might simply identify a markup you aim to achieve. For example, you might have prices that are twice your direct costs—yielding a ratio of 0.5, or 50%.
Divide your forecasted costs by the ratio. The product is your sales revenue forecast. Subtracting direct costs from sales revenue results in an amount for gross profit.
4. Overhead Expenses
Every business has general overhead expenses. Even the solo entrepreneur working from home must at least cover the cost of internet and cell phone use. Larger organizations of course incur expenses for rent and office administration. Don’t forget costs for advertising and marketing, even if that’s only website development and maintenance. Subtract these expenses from your gross profit to obtain net profit.
Over time, update your financial forecast. Poor results will necessitate cutting overhead and capital expenditures. On the flip side, beating expectations gives you extra funds for expansion.