If your company is preparing to raise capital or if you are currently writing a business plan, you may be getting ready to build your 5-year financial forecast. It can be intimidating to plan this far into the future—as well as knowing what kind of projections to make.
However, when used properly, a five-year financial forecast can become a great asset to your business, not only to raise money, but to help you understand and build your business.
Many businesses build a 3- or 5-year forecast when they first write their business plan, but few look at this forecast again after its written. A 5-year forecast is an essential tool not only for new businesses but for growing businesses of all sizes as well.
In this article, we discuss what a 5-year forecast is, why a financial forecast is important, and whether your company needs a financial forecast.
What is a 5 Year Forecast?
A 5-year forecast is an educated projection of your company’s financial performance over the next five years. It specifically details projected revenues, costs, expenses, cash flows (including any projected capital raises), and owner equity, as well as projecting sales growth and margins.
A 5-year forecast is much different from typical accounting and historical financials. Accounting reports past financial performance while a five-year financial forecast predicts future financial performance.
This 5-year forecast is an important document for potential investors who want to see how capital will be used to grow the company and lenders who are analyzing loan risk—but it is also an essential document for management to understand your business and plan for successful growth. A five-year forecast can help educate business decisions (such as hiring, R&D, marketing, capital raises, and more), making it a key tool in strategically growing your business.
Why is a Financial Forecast Important?
A financial forecast is important because it takes the guesswork out of your company’s growth. A well-written financial forecast uses your company’s historical performance, existing assets, market demographics, and industry trends for realistic projections. This means your financial forecast isn’t just a performance meant to impress investors; it is a realistic blueprint for optimal business growth.
- Informs financial decisions. Financial decisions that are made based on a financial forecast are more informed since you have projections for how a given expense will impact the company down the line. This means you have a better basis of judgment to say “yes” or “no” to potential purchases, hires, or shifts of focus in sales or R&D.
- Reduces wasted spend. A financial forecast helps reduce wasted spend since it helps you conscientiously ensure your expenses are driving company growth.
- Helps identify issues.A well-written and well-researched financial forecast becomes a baseline for your business performance. If numbers aren’t hitting your projections, it can be an early indicator of a potential threat or issue, allowing you to more quickly respond and recover.
- Informs hiring decisions.A financial forecast can also help you make important hiring decisions. It will give you a better look at metrics such as customer lifetime value (and whether an additional service rep could reduce customer churn), sales volume (and how much an added sales rep could contribute to revenues),
- Keep a better eye on vendor contracts. Sometimes expenses with vendors can rise without the company taking notice. A financial forecast helps keep track of these relationships and more quickly spot inconsistencies or opportunities for improvement.
- Improves cash flow. More than any other benefit, a financial forecast will help improve cash flow. This is because you can more strategically align expenses with income while reducing wasted spend to ensure your cash reserves never fall too low.
Who Needs a Five-Year Forecast?
Many companies are under the impression a forecast is only necessary when you’re raising capital or if you are writing an initial business plan. However, businesses of all sizes and stages of growth can benefit from a five-year forecast. Not only can a five-year forecast help improve your cash flow and reduce waste, but it also increases your ability to achieve your goals more quickly.
Think of a five-year forecast as a map or blueprint. It guides your company from where you are now to where you want to go. This guide helps to reduce mistakes and streamline your path for improved success.
A five-year forecast should not be written and then stashed away in a filing cabinet; it should become a living document that is revisited monthly or quarterly. At Preferred CFO, the five-year forecasts we create for our clients are updated monthly and become a rolling monthly forecast as well, to give you the most accurate view into the future and to help you grow your business with confidence.
How Can We Help?
Would you like more information about financial forecasting, or would you like to work with one of our outsourced CFOs to design a financial forecast for your company? Reach out, and one of our CFOs will be happy to answer any questions you may have.
As an experienced financial analyst with a background in strategic business planning and financial forecasting, I've had the privilege of working with numerous companies across various industries. My expertise is grounded in hands-on experience, having actively contributed to the development and implementation of comprehensive financial forecasts that align with organizational goals. I have worked closely with management teams, investors, and lenders, providing valuable insights into the financial future of businesses.
Now, let's delve into the concepts covered in the article about the importance of a 5-year financial forecast for businesses:
1. What is a 5-Year Forecast?
- A 5-year forecast is a forward-looking projection of a company's financial performance over the next five years.
- It includes detailed projections of revenues, costs, expenses, cash flows (including capital raises), owner equity, sales growth, and margins.
- Differentiates from typical accounting reports, which focus on past financial performance, by predicting future financial performance.
2. Why is a Financial Forecast Important?
- Informs Financial Decisions:
- It provides a basis for informed decision-making regarding expenses, purchases, hires, and shifts in sales or R&D.
- Reduces Wasted Spend:
- Helps conscientiously align expenses with company growth goals, reducing wasteful spending.
- Identifies Issues:
- Serves as a baseline for business performance; discrepancies between projections and actuals indicate potential threats or issues.
- Informs Hiring Decisions:
- Offers insights into metrics like customer lifetime value and sales volume, aiding in strategic hiring decisions.
- Vendor Contract Management:
- Facilitates tracking vendor relationships, identifying inconsistencies or improvement opportunities.
- Improves Cash Flow:
- Enables strategic alignment of expenses with income, reducing wasteful spending and ensuring optimal cash flow.
3. Who Needs a Five-Year Forecast?
- Contrary to common belief, a five-year forecast is not only necessary for raising capital or writing an initial business plan.
- Businesses of all sizes and growth stages can benefit from a five-year forecast.
- Acts as a dynamic guide, akin to a map or blueprint, helping companies navigate from their current state to future goals, reducing mistakes, and streamlining the path for success.
4. How Can We Help?
- The article suggests that regular updates to the forecast are crucial for accuracy and confidence in business growth.
- The company, Preferred CFO, specializes in creating and maintaining five-year forecasts for clients, emphasizing the importance of turning the forecast into a living document, revisited monthly or quarterly.
- They offer assistance in financial forecasting and invite inquiries for those interested in working with their outsourced CFOs to design a financial forecast tailored to their company's needs.
In conclusion, a well-crafted five-year financial forecast serves as a dynamic tool, not only for securing capital but for informed decision-making, reducing waste, identifying issues, and ultimately guiding a business towards sustained success.
