The famous financial forecasts are surely one of the elements of management accounting that causes the most headaches for entrepreneurs!

However, they are used to build the operating budget, i.e. the forecast income and expenses, as well as the working capital budget, which allows you to track inflows and outflows. There is an important nuance: not everything that comes into the company's coffers is income, and not everything that goes out is necessarily an expense.

Let's take the time to demystify all this.

How do you start the forecasting exercise?

Forecasting is a process that involves analyzing your past financial data and future assumptions to estimate outcomes over time . Here are some general steps to help you get started:

• Gather relevant financial data: your past financial statements, sales reports, and past budgets. Your strategic planning, or annual planning, can also be a good starting point.

• Take the time to review historical trends to identify upcoming changes. Understand the factors that have influenced past financial performance.

• With the help of your key employees, identify internal and external factors that may impact future financial performance. This may include market trends, economic fluctuations, or competition .

Remember, you are not selling dollars, you are selling goods and services, and it is always easier to visualize units than dollars !

The two types of budget

The operating budget is a reflection of the income statement and your operations for the next year. It will be built by taking the time to inventory income and expenses. It must be remembered that your variable costs are fixed unitarily, and that your fixed costs are variable unitarily , even if this may seem a little counter-intuitive! For a fixed cost for example, the annual salary of a bicycle mechanic of $40,000, which is a fixed expense, will be unitarily different if it is amortized on 800 bicycles sold at $50 per bicycle or on 20 bicycles sold at $2,000 per bicycle. For variable costs for example, if you pay $100 for your bicycles, the total amount of your bicycle sales will vary depending on the number of bicycles sold, but will always be unitarily fixed at $100.

This exercise should also get you thinking about your revenue and cost structure . And why not revisit your “ business model canvas ”? The business model canvas is a graphic illustration of the main elements of a business model that helps you identify your added value. It also helps you focus on your target customers and market segments and understand the resources and suppliers needed to carry out your activities. It can help you better understand and visualize your revenue and cost structure. It is a model that you can easily find online and that will help you better clarify your vision and therefore your forecasts.

The working capital budget is a reflection of your liquidity. It identifies your cash inflows and outflows. You will therefore need to start with the operating budget data, but add inflows and outflows not related to operations, such as loan repayments. In the working capital budget, you will estimate when the cash inflows and outflows will occur . For example, you make invoices payable in 30 days. What proportion of your customers will pay in 30 days, 60 days or more? At the end of the financial year, you should be able to estimate your working capital needs, check whether your operating credit is sufficient and have solid arguments to negotiate an increase in it.

Finally, why and for whom do we make forecasts?

This is not an easy exercise, financial forecasts are a management tool for your business: to better manage your development and understand where you are going. A budget is also a way to set objectives that should be SMART: Specific, Measurable, Achievable, Realistic and Time-bound. The budget must relate to defined criteria. It must be measurable. It must be based on elements that are within the team's reach. It must be defined in time. So, we set objectives, we analyze the gaps and we check if we achieve them . If necessary, we rectify the situation.

One interesting goal is to track gross margin . Gross margin is what is left of the company's revenue after subtracting the cost of goods sold. You can easily find your industry's gross margin ratio with data from the Financial Performance of Business and Industry in Canada website . With this public data, you can compare yourself in your industry sector. For example, you might ask yourself: is 25% gross margin good? If your industry averages 30%, that means you are underperforming!

Your banker, too, wants to know your working capital needs, in order to determine the amount of line of credit needed for your business and estimate your financial health.

I don't have a crystal ball, but the coming months will bring their share of challenges for entrepreneurs. One of the best tools for managing a business remains financial forecasting. By following best practices and adjusting to our environment and economic conditions, it is a way to predict the future of the business and be one step ahead to ensure that it will have the necessary liquidity and solid financial resources to meet its monetary financial commitments.