A forecast is an estimate of a business’s future income and expenses. It’s the first step in completing a budget and a set of projected (or pro-forma) financial statements. A business that is already up and running bases its forecasts on its past performance, its current circumstances, and its future plans. So a business that grossed $250,000 last year would use that figure as a starting point for projecting next year’s sales and would then adjust the figure upward or downward based on current circumstances (that is, state of the economy, entrance of new competitors, buying mood of customers) and future plans. The same rationale applies for forecasting expenses.

It’s harder to forecast the initial sales and expenses for a start-up. There are four common ways to go about it:

Most experts feel that finding a business comparable to the one you plan to start and asking the owner for input is the most effective method for forecasting the initial sales and expenses for a new business.

Most experts feel that finding a business comparable to the one you plan to start and asking the owner for input is the most effective method for forecasting the initial sales and expenses for a new business.

Budgets utilize the information generated by forecasts and organize a business’s income and expenses into specific categories. In most cases, a business completes its forecasts and budgets simultaneously. Organizing a business’s income and expenses into specific categories provides a practical way of tracking those numbers on an ongoing basis and helps a business answer the question, “Are we on track financially?”

Budgets also help a business in day-to-day decision making. For example, if a business budgets $10,000 a year for marketing, and midyear it has spent $5,000 of its budget, it knows that it can’t say yes to an advertising company that is trying to persuade it to buy a $7,500 marketing campaign for the remainder of the year without exceeding its budget.

To further understand, track, and document their financial performance, businesses should also complete historical and projected financial statements on a regular basis. The statements include the income statement, balance sheet, and cash flow.

The historical income statement reflects the results of the operators for a business for a given period. It records all the projected sales and expenses and shows whether the business is making a profit or is experiencing a loss. The balance sheet is a snapshot of a business’s assets, liabilities, and owner’s equity at a specific point in time. It is an important tool for measuring a business’s overall financial stability. The cash flow shows the money that is flowing into and the money that is flowing out of a business on an ongoing basis; it provides a real-time picture of a business’s cash position. Projected financial statements are similar to historical statements except they look forward rather than backward.

Completing both historical and projected financial statements takes some practice, and most business owners buy books, attend workshops, or work with their accountants to learn how to prepare the statements. If you aspire to obtain a bank loan, seek investment capital, or sell your business at some point, you need to maintain accurate financial statements. It’s difficult for a banker, investor, or potential buyer to analyze your business without historical and projected incomes statements, balance sheets, and cash flows to go by.