The Art of Business Forecasting - Part 6 of 8

According to Tim Berry, good forecasts are created by forming well organized, educated guesses based on research and past results. Duration: 7:37

In Series: Business Planning Webinar

  1. Creating a Successful Business Plan - Part 1 of 8
  2. The Three Parts of Your Business Plan - Part 2 of 8
  3. Crafting Your Business Strategy - Part 3 of 8
  4. Developing The Business Plan - Part 4 of 8
  5. Doing the Numbers in Your Business Plan - Part 5 of 8
  6. The Art of Business Forecasting - Part 6 of 8
  7. The Core Value of Business Planning - Part 7 of 8
  8. Business Planning Resources - Part 8 of 8

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So we've talked about how the financials fit together and where they go in your plan, but let's look at the hardest part, which is forecasting itself. Forecasting is more art than science. It's not as if you have some mathematical model that you're supposed to know or that you learn in school. Forecasting your future for your business plan is a matter of well-organized educated guessing based on what research is available and what past results are available. You can do this. Just take it step by step.

To start your forecast, try to estimate your sales in units. Now we know that some businesses sell in obvious units like boxes, and other businesses, typically services, will sell hours or days or what have you, but most businesses can rephrase their sales in units to make the forecast a little bit easier. Even attorneys or accountants can talk about hours as units. Breaking your sales forecast down into units makes it easier to move forward.

Let's take a restaurant as an example and assume that we can estimate units as meals, drinks, and other. We've got an estimate here that we established through some methodology. Depending on what your business is, it might be different, but with restaurants we might be counting tables and hours of the day and estimating how many tables are occupied for how many hours of the day and then figuring that for weekdays, weekends, and then by month.

Step-by-step, the math can be fairly simple, and what you end up with then is estimates for unit numbers for the first month. And simple math, you add the three numbers up and you get the total, which becomes a forecast for say the first month of a plan. And then from there, you're using the same kind of simple methodology, making assumptions about seasonality promotions, whatever to add in the other months until you have 12 months, which gives you the opportunity to add the 12 months up to calculate total annual units. In this case, we're looking at almost 23,000 for meals, 11,000 for drinks, and 240 for other might be cups or t-shirts, whatever.

And presumably, we study the market or we know the restaurant business or we do the math depending on the tables and we have a relationship of drinks to meals so that we can come up with an educated guess for this and then go from there to educated guess again for the second year and the third year of the plan to give us a basis for making a unit forecast. Once the unit projections are made, then we add some average prices, which of course are estimates. We're looking ahead. This is the future, so the average prices here are over the whole business over the whole month. This is what we see for the average price per meal, per drink, and per other items.

When we have units and prices, of course, it's simple math. Multiply units times price to calculate sales. We have 779 units times $15 each equals $11,685 of projected sales month of January for meals. And we do that for each of the three rows of sales and then add the three rows together to calculate $12,665 as the sales forecast for that first month. You can also calculate estimated projected direct costs using your already existing unit projections. Here we're saying that on average, a meal will cost $2 and therefore, you can see the calculation 779 meals costing an average of $2 each meal with result in $1,558 of direct costs for meals.

Then we add the costs for drinks and other to calculate total direct costs, which then finishes our forecast, a calculation based on educated guessing. And we can see in review we estimated unit sales. Then we added unit prices so we could calculate sales. Then we add direct unit costs and that gives us the calculation for direct cost of sales. It may look like a lot and complex when it's their altogether, but if you take ti step-by-step, it's easy. And again, you are uniquely qualified to project the future of your own business.

We move on then to the personnel plan, which is another simple list, simple math. You're looking ahead and estimating what you'll pay in wages, salaries, and compensations for the different people in your business. Here we see in January it's a simple sum to figure out that the total of all the salaries is $23,500. And from there we calculate all the months and add up the 12 months to get the per year calculation. And then from there, we add the second and third year to complete a personnel plan.

What you've done now is most of the work involved in creating and estimated profit and loss. You've done sales and costs of sales and you've done payroll, so as you add in operating expenses, that gives you profit before interest and taxes. With relatively simple calculations to estimate interest and taxes, you can then project profit and loss for the next 12 months, and here in this example, the second and the third year as well.

One final note that's important conceptually for this business planning, we use pro forma statements that look a lot like what you'd see in accounting. We've got the income statement, the cash flow, the balance sheet, and so on. Because they look so much like accounting, people tend to get lost and forget the difference between planning and accounting. Accounting starts today and goes backward into the past in ever-increasing detail. Planning on the other hand starts today and goes forward into the future in ever-increasing aggregation.

Don't try to make a plan in the same detail that you present past results to the tax authorities as part of your accounting. Estimate depreciation. Don't try to depreciate each item. Estimate your sales. Estimate your expenses. Don't pretend that you can do a complex mathematical model for this. You're doing a system of estimated guesses that work together to give you an idea for creating a plan for guiding decisions for moving your company forward in the right direction.

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