This post by Stephen Loy originally appeared on the Louisiana Technology Park blog.
Most business owners probably have a pretty good idea of what their revenue and costs are in a given month, but what about some of the other numbers? What about the formulas that can give you indications of how the business might perform in the future, and the kinds of decisions you should be considering? It’s not magic; it’s financial forecasting.
Too often business owners look at past performance as an indicator of what’s going to happen next, says Greg Crabtree, CEO of Crabtree Rowe & Berger. But relying on historic financial numbers in this way is like driving down a road with a blacked-out windshield and using the rear-view mirror to go forward, he says. Forecasting helps you look at what’s coming and determine whether you have the resources to meet it.
Here’s how to improve your financial forecasts.
Keep It Simple
There are all sorts of ratios you can create to drill down into different aspects of your business, but it’s easy to get lost in the weeds with that approach if you use too many variables. Instead, start with your revenue, Crabtree says. Then look at the direct costs that did not include labor, and subtract those direct costs from your revenue. The result is your gross margin, which is a predictor of performance, Crabtree says. Also, direct labor divided by gross margin is your labor efficiency ratio.
“By creating these connections, you can make forecasting so easy,” Crabtree says. It’s easy to tinker with these numbers and see what you should be doing to keep the business growing. “You can see where you overspend, and whether you can grow into it or cut it,” he says. “That’s the way we get [businesses] to transform. You can see the next stage.”