Home Forecasting

What is Financial Forecasting + Why it Matters for Small Business

Elon Glucklich

9 min. read

Updated November 27, 2024

Did you know that 30 percent of businesses close by their second year?

Business failures happen for a variety of reasons, but one of the most common is that owners simply run out of cash.  

And while some business ideas just don’t pan out, many times better planning could have kept the business open longer — maybe long enough to get access to funding, or do what’s necessary to turn things around.

So what does it look like when you’re proactive about your finances, and planning ahead to avoid unexpected cash crunches?

It looks like a financial forecast.

What is financial forecasting?

When you create a financial forecast for your business or startup, you’re making educated guesses about what’s going to happen in your business.

For existing businesses, a financial forecast is similar to a weather forecast. When you check a weather app on your phone to see if it’s going to rain tomorrow, you’re getting a prediction about what’s going to happen in the future, based on meteorological data from the past and present.

That’s exactly what financial forecasting is. You’re projecting your future sales, expenses, profits, cash flows, and other financial metrics, based on what you know about your business and your goals.

But what if you’re a brand new business or a startup, without any past data to build projections off of?

You can — and should — still create a forecast. Forecasting for new businesses and startups is about making educated guesses and assumptions based on your knowledge of your business, and revising those assumptions as you start to get actual data from running your business:  How long will it take to make your first $1,000 in revenue? How much will you spend on marketing in your first six months? How much cash on hand will you have at the end of your first year?

The beauty of forecasting is that it empowers you to make proactive decisions about aspects of your business that support your long-term goals. And unlike weather forecasting, creating a financial forecast doesn’t require any advanced training or education.

Not convinced? Consider that:

1. 1.If you’re an up-and-running business, you already have all the information you need: your profit and loss statement, balance sheet, and cash flow statement from the past months or even years.

1. 1.You know your business goals. It doesn’t matter if you’re a startup or an established business, you know what you hope to achieve by forecasting, whether it’s to find out when you’ll cross the break-even point, reach a revenue goal, or generate enough income to expand.

Financial forecasting might sound scary. But remember, all you need to forecast is an understanding of your numbers, and an understanding of your goals.

Types of financial forecasts

Different types of forecasts help you look at different aspects of your business’s financial future. Here are a few of the most common types of financial forecasts:

Sales forecasts

A sales forecast helps you predict how much you will sell in the coming months or years. If you’re an established business, you’ll look at your past sales, what’s happening in your market right now, and any patterns in your business (like seasonal ups and downs) to help you plan ahead. If you’re a startup, you’ll make educated guesses and assumptions based on your market research and goals.

Expense forecasts

This is the flip side of your sales forecast — it helps you predict how much money you’ll need to spend to keep your business running. Just like you might plan ahead for big personal expenses (like a new car or home repairs), expense forecasting helps you anticipate and prepare for business costs. This includes everything from the predictable stuff (like rent and payroll) to those expenses that can sneak up on you (like equipment repairs or rising supplier costs).

Cash flow forecasts

Remember how we mentioned businesses failing because they ran out of cash? The cash flow forecast helps prevent that by tracking money coming in and going out of your business. In its simplest form, it’s like keeping an eye on your business’s checking account balance – but projected into the future. This helps you spot potential cash crunches before they happen.

Income forecasts

Income forecasts (or profit forecasts) zoom in on your bottom line: How much profit will your business actually make after all expenses are paid? This forecast is particularly useful if you’re trying to get funding, as it shows investors a potential return, or demonstrates to lenders that you have a viable business.

Scenario Forecasts

This is the business version of playing a ‘What if” game. What if sales drop 20 percent? What if that new marketing campaign works better than expected? Scenario forecasting helps you prepare for different possibilities — both good and bad.

Financial forecasting examples

To really shine a light on the forecasting process, let’s look at a few examples.

Emma is planning to open a luxury pet spa. She knows she’ll need to spend money before she can make money, so she creates an expense forecast to understand her startup and ongoing costs.

Expense forecast

First, she lists out all her one-time startup expenses and assets she needs to purchase:

• •Building renovations to create grooming stations: $15,000
• •Equipment (grooming tables, tubs, dryers): $8,000
• •Initial permits and licenses: $2,000
• •Security deposit for retail space: $3,000

Total: $28,000

Then she calculates her monthly operating expenses:

• •Retail space lease: $2,500
• •Utilities (water, electricity, heat): $500
• •Two full-time groomers ($18/hour plus benefits): $7,000
• •Marketing budget: $1,000
• •Insurance: $300
• •Grooming supplies: $600
• •Business software subscription: $100

Total: $12,000

Emma’s forecast shows she’ll need about $28,000 to get started, plus around $12,000 per month to keep the business running.

By creating this forecast, Emma determines she’ll need to secure at least $64,000 to cover her startup costs plus three months of operating expenses.

Sales forecast

After working out her expenses, Emma needs to forecast her sales to see if her pet spa can be profitable. She researches her market and makes some educated guesses based on her experience as a groomer:

Her services will include:

• •Basic grooming package: $65 per dog
• •Luxury spa package: $95 per dog
• •Nail trimming: $25 per dog
• •Bath only: $45 per dog

To create her forecast, Emma considers:

• •Her spa can handle 8 dogs per day with two groomers
• •She expects to start at 40% capacity in month one, growing by 10% each month until reaching 80% capacity
• •Based on her experience, about 60% of clients will choose basic grooming, 20% luxury, 10% nail trimming, and 10% bath only
• •Most clients will return every 6-8 weeks

Here’s what her monthly sales forecast for the first three months of operation looks like:

Month 1 (40% capacity)

• •64 basic grooms (16 per week × $65) = $4,160
• •21 luxury packages (5 per week × $95) = $1,995
• •11 nail trims (3 per week × $25) = $275
• •11 baths (3 per week × $45) = $495

Total: $6,925

Month 2 (50% capacity)

• •80 basic grooms (20 per week × $65) = $5,200
• •27 luxury packages (7 per week × $95) = $2,565
• •13 nail trims (3 per week × $25) = $325
• •13 baths (3 per week × $45) = $585

Total: $8,675

Month 3 (60% capacity)

• •96 basic grooms (24 per week × $65) = $6,240
• •32 luxury packages (8 per week × $95) = $3,040
• •16 nail trims (4 per week × $25) = $400
• •16 baths (4 per week × $45) = $720

Total: $10,400

By month 6, at 80% capacity, Emma forecasts monthly revenue of about $13,800. Comparing this to her monthly expenses of $12,000, she projects that her revenues will be outpacing expenses around month 5 or 6.

For another example, let’s look at Whitney, who owns a successful bakery in a suburb of a large city. She’s considering expanding by opening a second location, this one in the city. She needs to create the following financial forecasts:

1. 1.An expense and asset purchase forecast for the new location. This will include higher lease and personnel costs, as well as different (and potentially more complex) transportation and logistics-related expenses.

1. 1.A cash flow forecast that will help her project whether she can afford the starting costs related to opening a second location.

1. 1.A scenario forecast that projects different levels of success for an urban location with more competition, but also more foot traffic. She’ll create best-case, worst-case, and middle ground scenarios, and forecast how each will impact her bottom line.

Let’s look at how she uses the different forecasts to make her decision.

Expense forecast

First, Whitney lists out her one-time startup expenses and asset purchases:

• •Building renovation: $45,000
• •Equipment (ovens, displays, etc.): $35,000
• •Permits and licenses: $3,000
• •Initial inventory: $5,000

Total startup costs: $88,000

Then she details her expected monthly expenses:

• •Retail space lease (prime downtown location): $4,500
• •Additional staff (higher wages for city location):
• •Utilities: $800
• •Daily delivery van rental and fuel: $1,200
• •Additional insurance: $500
• •Marketing budget: $2,000
• •Ingredients and supplies: $3,500
• •Payment processing fees: $600

Total monthly expenses: $30,600

Whitney’s forecast shows she’ll incur about $180,000 in operating expenses for the new location during the first three months.

Cash flow forecast

Whitney then creates a cash flow forecast to see if she can afford the expansion:

Starting position:

• •Current bakery's average monthly profit: $15,000
• •Savings earmarked for expansion: $50,000
• •Approved business loan: $100,000

First six months’ projected cash flow:

Month 1: -$95,000 (Startup costs, first month’s expenses, minimal revenue)

Month 2: -$20,600 (Full expenses, revenue building)

Month 3: -$10,600 (Full expenses, revenue increasing)

Month 4: -$5,600 (Break-even point approaching)

Month 5: +$2,400 (First profitable month)

Month 6: +$9,400 (Profitability improving)

This forecast shows she’ll need about $132,000 to cover her cash flow gap until the new location becomes profitable. Her combined savings and loan total of $150,000 should cover things, but with only a small cushion.

Scenario forecast

Since her projected cash needs don’t leave much room for error, and she doesn’t want to dip into profits from her current store, Whitney decides to create three scenario forecasts to understand how potential outcomes might impact her forecast:

Best Case Scenario:

• •Location becomes popular with office workers and weekend brunchers
• •Achieves 90% of suburban location's sales within 6 months
• •Monthly revenue by month 6: $45,000
• •Monthly profit: $14,400
• •Loan repaid within 18 months

Middle Ground Scenario:

• •Steady growth but more seasonal than suburban location
• •Achieves 70% of suburban location's sales within 6 months
• •Monthly revenue by month 6: $35,000
• •Monthly profit: $4,400
• •Loan repaid within 3 years

Worst Case Scenario:

• •Struggle to build consistent customer base
• •Achieves only 50% of suburban location's sales
• •Monthly revenue by month 6: $25,000
• •Monthly loss: -$5,600
• •Would need to make significant changes or consider closing location

This scenario forecast helps Whitney understand her risks and opportunities. She realizes that even in her middle-ground scenario, the expansion could work – but she’ll need enough cash runway to survive the first 4-5 months of losses, and she should have a plan ready in case the worst-case scenario starts to materialize.

Start financial forecasting in your business

Financial forecasting isn’t just about predicting the future — it’s about preparing for it. Whether you’re starting a new business or growing an existing one, taking the time to create financial forecasts can help you avoid cash crunches and make better business decisions.

If you’re ready to get started, check out our guide on how to create a sales forecast, then download our free cash flow forecast template to begin mapping out your business’s financial future.

Consider using a financial forecasting software like LivePlan as well. With LivePlan, you can create multiple forecasting scenarios, compare your forecasts to your actual accounting data, get an AI-powered monthly review that analyzes your business performance each month, and other features that help you spend less time building and updating your sales forecasts, and more time analyzing performance to make better decisions.

Remember, the goal of forecasting isn’t to make perfect predictions — that isn’t possible. It’s about proactive planning, and putting your business in the best position to succeed by avoiding unexpected problems.

Elon Glucklich

Elon is a marketing specialist at Palo Alto Software, working with consultants, accountants, business instructors and others who use LivePlan at scale. He has a bachelor’s degree in journalism and a Master of Business Administration from the University of Oregon.