Why stormy economic weather makes financial forecasting vital

Rarely, if ever, have economic headwinds presented more challenges for small businesses than today. The 2008-09 global financial crisis was unprecedented, but current cost-of-living pressures, which show little signs of easing, present new fears for millions of small businesses still trying to put the impacts of the pandemic behind them.

Today, many of those small businesses are – understandably – taking a short-term view in an attempt to overcome the volatility and uncertainty they face. For them, thinking long term when short-term challenges are so severe, feels like a luxury. According to ASIC data, 65-70 per cent of businesses that entered insolvency during the last 10 years were small businesses with fewer than five full-time employees.

In the four-year period from June 2019 to June 2023, one in three of all businesses closed permanently according to ASIC data. Small businesses were significantly more at risk than large businesses, with the so-called survival rate for new sole proprietors – the smallest business structure – just 41.5 per cent.

While there are so many factors that contribute to business failures, one of the most common is the absence of a robust and long-term financial plan. Financial forecasting is a cornerstone of any small business's success long term and a bridge over uncertain water in the short term.

However, many SMEs find this area challenging to navigate, particularly today under the clouds of volatile and uncertain economic conditions. That’s where accountants come in.

The once traditional and well-defined role of the accountant is evolving. Many small businesses rely on their accountant for day-to-day bookkeeping, tax returns, payroll, tracking expenses, etc, but also for insights on an organisational level, like how to curb spending, identify additional revenue sources and accelerate business growth.

As the remit of an accountant continues to change, financial forecasting is growing in importance as a service to offer clients and a necessity to safeguard their own business’s longer-term health. But what is financial forecasting, and why is it important? What are the key components? And how can it help small businesses take charge of their finances in 2024?

What is financial forecasting?

Financial forecasting is the process through which businesses predict future performance and devise future strategy. It’s based on a combination of their historic performance and potential external market conditions. By estimating future revenue, expenses, cash flows, financial barriers and other metrics, small businesses can make informed decisions about, for example, budgets, resource allocation, investment opportunities, pricing their product or service, risk management and more.

It enables businesses to build healthy long-term foundations and better navigate the inevitable shorter-term peaks and troughs of running a small business. Financial forecasting holds immense importance for these small businesses, because it enables them to anticipate potential challenges, identify opportunities for growth, and plan strategies accordingly. Foresight is a competitive advantage, as it enables businesses to avoid or eliminate potential issues while they’re still comparatively manageable.

A financial forecast varies depending on factors like the size of the business, the industry it operates in and the type of data it can access. Typically it would include, for example: projected revenue, anticipated expenses and overheads including payroll, taxes and award rates, cash flow projections – taking account of seasonal fluctuations, like those experienced by a retailer selling beach accessories in Melbourne – and balance sheet forecasts.

This historic and real-time internal data is then combined with external market trends that impact businesses. That can include interest rates, global and Australian inflation, potential regulatory changes and more. This element of a financial forecast forces small businesses to think more holistically, and consider issues that are influential but easy to forget, like Australia’s relationship and trade agreements with China or changes to the minimum wage.

Based on the insights it creates, a financial forecast empowers small businesses to adapt proactively, overcome risks and make informed decisions that align with their long-term objectives and growth. Being a partner in that growth is a key role of today’s accountant – who is an adviser now, not an administrator.

The small business community is vast and vibrant, but the challenges it encounters can be – and often are – steep enough to spell the end of many businesses. Through a financial forecast and a focus on the long-term rather than short-term, accountants can help businesses mitigate risks, pursue opportunities and grow sustainably – whether that’s on behalf of a client or for their own operation.

Vijay Sundaram is chief strategy officer at Zoho.