As a savvy startup owner, you probably wish you had a crystal ball to see into the future. You'd like to predict future expenses and plan for the unexpected.
Many early-stage startups with limited resources and minimal finance backgrounds rely on spreadsheets to predict spending. While the color coding and the neat rows and columns may feel organized and effective, a spreadsheet doesn’t analyze for you or help you make predictions. Its "future-seeing" power is limited.
The good news is that there are more effective ways to approach spend forecasting. This article will explore using real-time data and a strategic mindset to make better predictions and improve your startup's financial health. Keep reading to learn how to achieve a more informed and confident approach – no crystal ball required.
What Is Spend Forecasting?
Spend forecasting is predicting future expenditures for your business or organization. It helps you track and anticipate cash flow and other financial metrics, such as operating expenses, capital expenditures, and revenue. You can use this data to make informed decisions about your financial future by analyzing historical spending patterns and considering plans and initiatives.
You need to prepare for just about any situation, which is where scenario planning comes in. You can use forecasting to prepare for different outcomes, even highly unlikely ones. This ensures that you won’t be caught up in a surprise if something changes.
Spend Forecasting Methods
There are a few different methods that you can use for forecasting expenses. Which makes the most sense for your business depends on exactly what variables you want to see. Let’s dive deeper into each method and when it’s useful.
Historical forecasting involves analyzing past patterns, trends, and relationships in data to make educated guesses about future expenses. This type of forecasting assumes that the future will resemble the past and that current trends and patterns will continue.
For example, if you look at your expenses for the past five years and notice a consistent year-over-year increase of 10% each year, you can expect it will be the same this year if you continue to grow at the same pace.
You’ll typically use historical forecasting when making longer-term predictions than with time series forecasting (discussed below). This method does not account for any market changes or seasonality. So, the results might be inaccurate without any other context. It's best to use multiple forecasting techniques whenever you can.
Time Series Forecasting
Your company might use time series forecasting to predict future expenses in a specific time period based on past sales data. The most important benefit of time series forecasting is it helps you look at seasonal or time-dependent trends, whereas historical forecasting (which is similar) does not. In practice, you're taking time-stamped data and determining trends to predict future sales, assuming the future will follow the same trends as in the past.
Causal forecasting considers the underlying cause-and-effect relationships between variables to make predictions. Unlike historical forecasting, which relies solely on past trends and patterns, causal forecasting takes historical data and adds external factors into the mix based on different scenarios.
External factors include things like economic changes, consumer behavior, or competition. As a fun nostalgic example, take the local ice cream truck driver. To predict future ice cream inventory expenses, the driver would need to use causal forecasting to account for the weather, time of year, and day of the week. They would use this information to determine how many Choco Tacos and ice cream sandwiches to have on hand and when.
Top-down forecasting starts with an overall, high-level forecast, like a spend forecast for the entire company. From here, you’d break that forecast into predictions for individual departments, products, or markets. Each department can then set budgets accordingly.
We’re looking at essentially the opposite of top-down forecasting here! Instead of building a forecast for your company as a whole, you would start with smaller forecasts for each department or market. Combine all of those models to get the top-level forecast or a more holistic view of your cash flow.
Building And Implementing A Spend Forecast
Key Factors To Remember
Now that you have a quick overview of different types of forecasting, you'll need to adopt a few key characteristics to put one into action:
1. Be goal-oriented. Know where you're going to determine your forecasting methods and metrics.
2. Be informed and realistic. Remember that you're making assumptions, and there's always a chance you'll be wrong. However, the right information and methods can help you make an informed assumption.
3. Be collaborative. Building and implementing a forecast is a team effort, requiring collaboration between finance, operations, and other relevant departments.
4. Be vigilant and flexible. Constantly monitoring, reviewing, and adjusting your forecast for accuracy is how you maintain of your predictions and know when to make changes.
8 Steps For Creating & Maintaining
Although building and implementing a forecast can seem overwhelming, it doesn't have to be if you follow these steps.
1. Determine your forecasting goals – Define the specific purposes for your forecast. This may be reducing costs, improving cash flow management, or making better business decisions.
2. Gather data – Collect relevant data from your sources, like invoices, bank statements, and internal reports. Ensure that the data is up-to-date, comprehensive, and consistent.
3. Choose a forecasting method – Select a method appropriate for your company's specific needs based on the methods we outlined above.
4. Determine your time horizon – Do this by considering the level of detail you need to meet your goals. A longer-term forecast can provide valuable insight into the company's future spending but may also be less accurate due to changing market conditions and other factors. A shorter-term forecast can provide more accurate data but may not offer the level of insight into the future that a longer-term forecast can.
5. Make assumptions – Identify and make assumptions about future growth rates, inflation, and other factors impacting your spend forecast.
6. Collaborate with stakeholders – Engage relevant stakeholders in the forecasting process to ensure everyone understands the data and methodology.
7. Monitor and review – Regularly monitor and check the accuracy of your forecast and make any necessary adjustments based on new information or changing conditions.
8. Use the forecast – Put it into action! Use it to inform decision-making, manage costs, and achieve your cash flow goals.
Tools And Software For Spend Forecasting
Microsoft Excel is a widely used tool for forecasting. It is easy to use and provides basic functionality for building and tracking forecasts. However, Excel can be time-consuming and error-prone when used for complex forecasting tasks and may not be suitable for startups with a large number of expenses.
As far as crystal balls go, it's decidedly unhelpful at predicting the future.
Budgeting and forecasting software provides a range of advanced features not available in Excel. Financial planning and analysis (FP&A) software is a comprehensive tool that can provide a range of capabilities for forecasting, including scenario analysis, cash flow management, and risk management.
The right software helps cut down on inaccurate forecasts and time spent forecasting manually. Look for software with real-time data and analytics capabilities so that you can make more accurate predictions.
Benefits Of Spend Forecasting For Startups
Here are a few concrete examples of how spend forecasting can help you:
- Cost reduction – By forecasting spending and costs, you can identify areas where you can cut expenses. For instance, if you forecast that you will have to spend a lot on office supplies in the coming months, you can negotiate better prices with suppliers or switch to more cost-effective options.
- Improved cash flow – Spend forecasting provides up-to-date information on your future spending and income, helping you plan for any short-term cash flow gaps or surpluses. This allows you to manage your cash flow better and avoid any financial surprises.
- Risk management –Forecasting your expenses helps you anticipate potential risks, such as unexpected cost spikes or reductions in income. With this information, you can make contingency plans and minimize the risk of financial problems.
- Increased efficiency – By anticipating your future spending and income, you can optimize your operations and use your resources more effectively. For example, if you forecast a surge in demand for your products in the coming months, you can ramp up production to meet that demand, reducing the risk of missed opportunities or unfulfilled orders.
Other Considerations Specifically For SaaS Startups
Forecasting future revenue and managing costs is crucial for the success and growth of SaaS startups. Forecasting becomes vital for ensuring sustainability with a recurring revenue model, where customers pay monthly or annually for software access. Additionally, SaaS startups often face a high customer acquisition cost and rapid growth, which can impact their bottom line.
Spend forecasting helps align expenses with your company's revenue and growth goals, manage costs associated with scaling, and maintain profitability with usage-based pricing. It also helps ensure continued innovation and competitiveness by managing R&D expenses.
Why Forecasting Methods Set You Up For Success
Effective spend forecasting is crucial for startups to succeed. Using forecasting methods, startups can reduce costs, improve cash flow management, help you make better decisions, reduce risk, and increase efficiency. When creating a forecast, consider its purpose and how to design it to match your needs.
Additionally, your startup should take a strategic approach to spend forecasting, leveraging real-time data and software to create accurate and relevant forecasts. By following these best practices, you can set your startup up for success and ensure that its forecasts support the effective management of your business.