Why Forecasting is Important for Business Growth and Success
You want to grow your business, but how do you figure out the best time to invest in growth? Should you attempt to anticipate market trends? Look to your competition for direction?
While these are elements of successful market research, which should help inform your planning process, the best way to approach growth is by looking at your financials. Specifically, by using historical and current data to create forecast scenarios.
In this interview with Sabrina Parsons, the CEO of Palo Alto Software, she explains exactly how forecasting can help you build a solid growth strategy.
How do business owners know when to invest in growth?
You always have to think about macroeconomics—the U.S. economy and the world economy—because that gives you some sense of “can I grow right now, or how hard will it be to grow right now? Look for trends, do industry and market research.
But at the end of the day, figuring out whether or not it’s a good time to grow comes down to strategic, lean business planning. It requires you to take the time to understand what opportunities you have for your business, and which areas of your business you should focus on. As part of that strategic lean planning process, you are going to have to build a financial forecast—sales forecasts and cash flow forecasts in particular.
You need to be able to look at your numbers but understand all your drivers. Running different financial scenarios helps you figure out if you’ve got an opportunity on your hands. And using a business dashboard tool like LivePlan makes it easier to create and review your forecasts regularly, without complicated spreadsheets.
For example, what happens when fuel prices go down by X percentage? How does that really affect your cost structure? Is there enough money for you to actually re-invest?
What common mistakes do entrepreneurs make when trying to grow?
The biggest mistake entrepreneurs make is not understanding how much cash they need to grow, and how your cash flow impacts your ability to survive a growth opportunity. Growth is cash-intensive.
There are very few businesses that can grow without having access to cash or capital, even service businesses. In order to grow, service businesses usually need to hire more people. You usually need to hire them and train them before you start producing.
Also, anybody who has inventory understands that inventory costs a lot of money. Not a lot of entrepreneurs totally get how it can put them out of business.
Imagine that you get a Walmart order you’ve been dying to get. They want to order 50,000 widgets, so and you’re going to have to produce those widgets and send them to Walmart, usually shipping on your dime.
If you’re lucky, Walmart will pay you in 90 days. So for 90 days minimum, you’ll have spent the money to produce and ship 50,000 widgets, but you won’t have payment yet. That invoice is just sitting in your accounts receivable; you can’t use that money to pay your bills until Walmart pays you. That’s a huge cash outlay—it can actually put your business completely out of business if you haven’t planned correctly.
And that is the number one mistake businesses make: not understanding the cash flow implications of growth.
Should brand new business owners be thinking about growth from the very beginning?
Yes, absolutely. You should investigate and understand the capital requirements for growth right from the beginning. You need to do a cash flow forecast. Then you can see, “Oh okay. I can deal with that. My business can get a $100,000 credit line,” or, “Oh crap. I don’t have access to that much money. Maybe I need to pare down my growth plan.”
Running sales forecasts and then looking at your cash flow forecast will help you understand whether you need to slow down your growth, or whether you can actually speed up your growth.
What you may have to do is plan longer-term for growth. You may have to say, “Okay, I’ve done my strategic forecast. I don’t have access to all the cash I need to grow the business, so, for the next six months, I’m going to plan to put money away so I have the cash I need to grow,” or, “For the next six months, I’m going to make sure my books and my finances look perfect, and that I pay all my vendors and increase my credit score, so that six months from now, I can apply for a line of credit. Then I can plan for growth.”
Again, if you’re going to grow, you’ve got to forecast and look at different scenarios. You have to know what it takes to grow. Are you ready to grow aggressively right now, or do you need to plan for slow growth?
At Palo Alto Software, we’ve grown while being profitable and cash flow positive. It means growth has been slower than it might have been if somebody invested $5 million. But the growth is still there. It has just been very purposeful and very careful, especially in the beginning when we first launched LivePlan.
How did you and the team at Palo Alto Software plan for growth?
When we launched LivePlan, we put a lean plan together. Using as much information as we had, we guessed what was going to happen, and then did small tests to see if our assumptions were correct so that we didn’t risk the entire business.
We said, “Okay. We currently sell this Windows product. It’s an okay business model but we want to change to this new business model—a subscription model. What does that change do to our cash? What does that do to the company and the revenue?”
It was very purposeful and there was a lot of testing and a lot of time spent validating ideas before we completely switched business models.
We transitioned slowly. In fact, we’re still transitioning. You can still buy our legacy product, Business Plan Pro, but at this point, 90 percent of our revenue comes from LivePlan. That has happened over the last four and a half years and very carefully and purposefully, always looking at strategic forecasts and then at plan versus actual: How did we do compared to our plan? Did we hit our metrics? If we didn’t, why? Are there places we can optimize our cost structure? Are there places we can optimize our conversions and customer targeting?
It’s important for us to always be very careful and diligent and to keep an eye on what we plan, what we did, and how we performed in the previous year so that we always have a big picture context of what our numbers mean to us.
What are the key things that growth-minded business owners should focus on?
Firstly, “Do I have enough money in the bank? If I don’t, do I have access to financing so that I can get money?” Growth is going to take capital.
Secondly, “Do I have the right managers on board as I grow?” As a business owner, one of the biggest pain points can be a lack of time. In order to grow, you need to be able to delegate.
Say that you’re opening a second restaurant; you focus all your attention on the new restaurant. Meanwhile, the original restaurant that was doing fantastic just falls apart because it turns out that you needed to be there one hundred percent of the time in order for it to be successful. The only way to solve this problem is to have good managers on your team to keep everything running smoothly so you can focus on other things.
And finally, why do you want to grow? Do you want to grow because you want to build an empire and own it? Do you want to grow because that’s the only way you can see to bring in more revenue and because you want to put money aside to send your kids to college, or for retirement?
It’s important to really understand what your personal goals and objectives are because growth is going to take a lot of work and blood, sweat, and tears so it’s important to have a very clear idea of what you’re trying to accomplish. If your goal is to sell the business, you have to know what it’s going to take to do that. Maybe in your industry, you can only sell your business if it’s reached a certain revenue benchmark. In that case, that’s what the goal is.
Growth can be a structured process
A lot of the time, business owners are just growing to grow. There’s so much involved in growth that knowing why you want to grow and what you want to get out of it is a really important exercise. Having this answer can help guide your market exploration, the type of scenarios you run, and the decisions you’ll make as you pursue growth.
Editor’s note: This article was originally published in 2016. It was updated in 2021.