Congrats! You have the capital. You’re maintaining customers. You’re in the rhythm and smooth sailing.
Then your investors ask you what your plan is for the next 12-24 months – to “predict” the future of your business.
Take a breath. We have the answer!
Financial forecasting is predicting your future financial state based on existing and historical data. If you can't make a reasonable prediction, securing funding, managing cash flow, and reaching financial goals may be difficult.
While financial forecasting may feel as scientific as gazing into a crystal ball, different methods can help you forecast based on your startup goals. Entrepreneurs often lack the resources and knowledge to forecast their financial situation accurately. The more you understand the methods available, the better you'll understand your startup's financial situation.
With the right resources, you can use forecasting to make more informed decisions and increase your startup's chances of long-term success.
Types Of Financial Forecasting Methods
Financial forecasting is essential for any business, particularly startups. But with limited financial expertise, how do you decide which method is best for your business? We'll explore some of startups' most common financial forecasting methods and how they can impact your bottom line.
Quantitative Forecasting Methods
Quantitative forecasting methods use numerical data to predict future cash flow and other financial indicators. They provide a more objective approach to predicting the future, as they consider historical trends to make assumptions about what may happen in the future.
Quantitative forecasting is particularly useful for startups, as it considers the rapidly changing economic environment where startups must often operate. The following methods are popular among startups.
1. Straight Line
The straight-line forecasting method uses linear projections of historical data and assumes that the trend will continue in a straight line. The advantages of this model include its ease of use and the fact that you can apply it to any industry. However, it doesn't consider any changes or unexpected events that could occur in the future.
Suppose your startup is attempting to forecast sales over the next three years. With a straight-line forecasting model, you would use the sales data from the previous three years and project that trend into the future. This can help you budget for any potential increases or decreases in sales and anticipate how much you will need to invest to meet your financial goals.
2. Simple Linear Regression
The simple linear regression method is similar to the straight-line forecasting method. It uses statistical techniques to measure the relationship between two variables (like sales and expenditures) and then projects those changes over time. This method considers data changes or fluctuations and can provide more accurate forecasts, but it requires more extensive data analysis and can be more time-consuming.
Let's say you're trying to predict future sales based on customer feedback and other industry trends. Using a simple linear regression model, you would consider all the relevant factors affecting sales and project the data into the future. Measuring the relationship between customer feedback and sales can help you more accurately forecast future sales trends.
3. Multiple Linear Regression
The multiple linear regression forecasting method considers numerous variables when making projections about the future. This makes it a powerful tool for startups as it can account for day-to-day market changes or sudden events that could affect your finances. But it does require a deeper understanding of the data and more advanced statistical techniques to be successful.
Imagine your startup is attempting to predict the cost of materials for its product. With a multiple linear regression forecasting model, you can account for the cost of raw materials, labor costs, and other industry trends to make more accurate projections about future expenses. This type of financial projection can help you budget and forecast to ensure you have enough capital to produce your product.
4. Moving Average
The moving average forecasting method is a simple yet effective way of predicting future trends based on past data. It takes the average of recent values and projects them into the future. This can be useful for startups as it indicates what will happen in the near future, allowing you to plan and budget accordingly. However, a limitation of this method is that it may not account for drastic changes in the market.
For instance, if you're trying to predict the value of a particular commodity, you can use the moving average method to get an idea of what will happen in the short term. In cases where the cost of materials can fluctuate rapidly, this method can help you plan for any potential increases or decreases in costs.
Qualitative Forecasting Methods
Qualitative forecasting methods use market research and expert opinion to make predictions. These methods can provide valuable insights into consumer behavior and industry trends, allowing startups to anticipate changes in the market better.
1. Market Research
Market research collects data from surveys, focus groups, and interviews to gain valuable insights into consumers' thoughts and how those opinions might affect your business. However, it's important to remember that consumer sentiment can change rapidly, and market research may not always provide an accurate picture of the future.
Let's say your startup is launching a new product. Market research can help you get feedback on your product's design, features, pricing, and other aspects before it launches. The data gives you an idea of how consumers might react to your product once it's released and allows you to adjust accordingly.
2. Delphi Method
The Delphi method involves gathering opinions from experts and synthesizing them to form a consensus. This method can provide valuable insights, as it considers multiple perspectives on a given issue. However, this heavy reliance on opinion-based data means the Delphi method may not be able to provide reliable forecasts.
For instance, if your startup is trying to predict the future of a particular industry, you can use the Delphi method to collect opinions from experts in the field. By considering their perspectives on potential changes and trends in the market, you can make more informed decisions about how to position your business for success.
Why Are These The Best Financial Forecasting Methods For Startups?
Financial forecasting methods can be a powerful tool for startups. By leveraging quantitative and qualitative methods, you can gain valuable insights into the future and adjust your business strategies accordingly.
Both methods offer startups a range of benefits. Depending on your needs, you can select the most appropriate method or combine several models to get a more accurate picture of future performance.
Ease Of Use
These methods are relatively easy to implement and understand. You can build them quickly and make decisions on the fly. They also don't require a ton of technical know-how, but you can utilize accounting software if you need support.
Quantitative and qualitative methods can provide valuable insights into future financial performance. By predicting market changes and adjusting different variables, you can plan for budgeting constraints, capitalize on increasing demand, and adapt your strategies accordingly.
You can conduct these methods with limited resources, making them ideal for companies that lack an extensive team or a large startup budget. You can use the data you have to make informed decisions and plan or implement new strategies based on the results.
As long as you have accurate financial data, you can use programs like excel or accounting software to create models on an as-needed basis.
Build Models On The Fly
You can build these models quickly — allowing you to make real-time decisions and adjust your strategies accordingly. This is especially beneficial for startups, as it will enable them to respond rapidly to changes in the market and capitalize on opportunities when they arise.
By understanding the market, collecting opinions from experts, and using the data you have to make informed decisions — you can plan for success in the future. With these tools at your disposal, you can also gain valuable insights into how consumers will respond to your product or service. This can help you adjust your strategies and stay competitive in the ever-changing market.
Working With Different Methods Of Financial Forecasting
Financial forecasting is essential for founders who want to understand how their businesses will perform in the future.
Quantitative methods provide a more technical approach to predicting the future, using historical data and statistical models. Industries where financial performance is predictable — such as retail or banking – use these methods.
Qualitative methods, on the other hand, rely heavily on opinion-based data. This is helpful when predicting consumer trends or market conditions. E-commerce businesses, for example, can leverage qualitative methods to understand better how customers feel about their products.
Regularly reviewing and updating your models is the best way to ensure you make decisions based on the most up-to-date information, so you can quickly respond when change occurs.
You can still benefit from financial forecasting if your startup doesn't have a dedicated finance team. Accounting software and budgeting tools can help you create detailed forecasts, allowing you to make informed decisions without breaking the bank.