How to Forecast Your Annual Profits

Get advice on forecasting profit for the next year.

By Marcia Smith

Cash or accrual?

You can forecast your profits on a cash basis - looking at what the balance in your bank account will be on a future date - or on an accrual basis, which factors in your assets and any money you’re owed or are owing.

The latter is more commonly used for forecasting, but the former is helpful in small businesses with low cash reserves. When possible, forecasts are worth doing at least 3 years ahead, and should ideally be updated and revised quarterly to give you the most accurate profit prediction.

Look at total income and outgoings

The first step in forecasting is to look at total income and expenditure for the last full year you have accounts for. These should be picked through in detail, removing any outlying or uncommon income or expenditure that might occur to try to build up a picture of what an average year looks like. If you have accounts for multiple years, you can put the figures together to create a more reliable average for your profit prediction. If you’ve no accounts, you may want to look at some from similar businesses or to seek advice on the likely costs of your upcoming activities.

Build a clear picture

The next stage is to build a year-on-year picture of income and expenditure. It’s recommended to start with expenditure - a basic breakdown of this will give you an idea of the level of revenue you need to generate. You may find it helpful to split expenditure into two groups. In the first group are fixed costs/overheads; these are costs that are unavoidable regardless of what activity you undertake and unlikely to change a great deal, such as rent, utilities, insurance and salaries.

In the second group are variable/ project costs, which can be marginally adjusted according to your activities, such as marketing costs, supplies and freelancer fees for specific projects. Splitting expenditure into two headings in this way can help you gain a clearer picture of what business decisions are expedient and affordable.

Your projected income

You can now add projected income, using a similar method of collecting data and building averages - if necessary going back to your variable costs to adjust them again in line with what’s needed to generate the income. What you’ll hopefully be left with at the end is profit, which you can keep in the bank, draw dividends from or plan to reinvest as part of the following year’s forecast. If not, it may be time to go back to the drawing board and adjust the business plan.

Find a middle ground

One big question is whether to forecast in line with the best or worst scenario for your business. While larger businesses will run several forecasts simultaneously – often taking into account wider factors such as forecasted inflation rates, industry trends and even government policy changes that may happen – the most common advice for those with only the time for one, is to try and find a middle ground between optimism and pessimism.