Imagine this. You walk out to your car first thing in the morning to drive to the office. You open the door… get in… put your seat belt on… and start the car.
You wrap a blindfold across your eyes and tie it around the back of your head so you can’t see anything. Then you put the car in reverse and begin your journey!
How far do you think you will go before you hit something? Not far, right?
But That’s What’s Happening in Many Businesses Today
What’s interesting is that the same entrepreneur or business owner that would never put a blindfold on while driving their car is essentially doing the same thing every day when it comes to running their company.
They are hurting their profitability and cash flow (and creating stress and frustration in the process) because they are cruising along on the highway of business with a blindfold wrapped across their eyes. The question isn’t whether there will be an accident. The question is how bad will the crash be… and will the business survive it.
A Reliable Financial Forecast to the Rescue
The cure for this problem is to implement one of the most powerful tools in business – a reliable financial forecast.
Creating the forward looking view of financial performance is a surprisingly effective way to transform the financial future of your company. It will:
- Help you drive growth, profitability and cash flow higher
- Create confidence and clarity about where your business is going financially
- Provide the roadmap for turning your vision and strategy for your business into a crystal clear view of what success should look like financially
- Enhance confidence and credibility with lenders and investors so they provide the capital and support you need to grow your business
- Help you make more confident, profitable financial decisions
In short, a reliable financial forecast will help you win financially in business.
Now Try This…
Stand up and cover your eyes with both hands so you can’t see anything in the room. Now walk to the other side of the room without uncovering your eyes.
That was uncomfortable wasn’t it? Even in a room you are very familiar with, it is uncomfortable trying to do a simple thing like walk to the other side of the room when you can’t see anything in front of you.
Now let’s try that same experiment again, but with a twist. This time separate your fingers just a wee bit so you can peek through your fingers. Now walk across the room.
Much more comfortable isn’t it? That little bit of visibility is enough to prevent you from running into something.
That’s what a reliable financial forecast (a financial projection) is all about.
Not providing complete visibility or certainty. Just providing a glimpse of what lies ahead so you can get where you are going safely.
Defining a Reliable Financial Forecast
By “reliable,” I’m referring to the goal of providing a tool or process for strategic decision-making. In forecasting, reliability trumps precision. Chasing precision when creating a forecast will distract you from the goal—helping you make wise strategic decisions.
By “financial forecast,” I’m referring to a living, breathing tool that is updated monthly. The basic format should track with your existing financial statements (income statement, balance sheet, and statement of cash flows in the same format you use for monthly financial reporting) for at least the next 18 months to compare monthly forecast results side-by-side with actual results.
Let’s take a look at how financial forecasting fits into the monthly financial rhythm of business.
Business moves in a rhythm, a cycle. So does financial management.
I call it the TARGET, MONITOR, ADJUST cycle. It’s about setting financial goals and targets, monitoring forecasts and actual financial results, and making adjustments in strategy and execution inside the business when financial results differ from the target or expectation.
The monthly financial rhythm begins with setting financial goals. Those goals are then turned into a financial forecast. That way you have clear financial goals expressed in terms of their impact on your profitability, financial position, and cash flow. Then actual financial results can be monitored against the forecast (or expectation).
5 Rules for Creating a Forecast You Can Trust
Creating a reliable financial forecast does not have to be a difficult process. It is really a matter of using a few basic principles together with your intuition and knowledge about the business. Here is a five-step process for creating a forecast you can trust.
Forecasting Rule No. 1: Think Decision-Making, Not Precision. One thing stopping you from creating a forecast is thinking that you don’t know exactly what the future holds and what will happen if your forecast is wrong.
Transaction processing and creating historical financial statements is about being right. (Here, precision is your friend.) On the other hand, forecasting is about improving the company’s ability to make wise decisions. (Here, precision is your enemy.)
As you create and use forecasts and projections, think decision-making, not precision.
Forecasting Rule No. 2: The Near Future Almost Always Looks a Lot Like the Recent Past. One of the biggest mistakes business owners make in creating a forecast is that they start with a clean slate – a blank spreadsheet to begin thinking about what the first month in the forecast will look like.
The first step should be to drop in actual results for the past 6-12 months. Have the revenues and expenses been coming in as expected? Can you see a trend developing? Are you surprised by any of the numbers now that you are looking at the past six months of actual results next to each other?
Forecasting Rule No. 3: Consider What Is Changing. Once you have a good view of what the financial results have been over the past 6-12 months, look at some of the factors that can make the next 6-12 months vary from the historical results.
Think through how the business is changing and its likely impact on your profitability and cash flow. Is the business seasonal? Does customer activity seem to be picking up or slowing down? Is there a big payment coming due on your line of credit?
Forecasting Rule No. 4: Be Conservative. Because we know the forecast will not be perfectly accurate, the challenge is keeping it in the “ballpark”. Therefore, be conservative in your key assumptions.
That way the surprises are pleasant rather than unpleasant.
Forecasting Rule No. 5: Use the “Smell Test”. An important step in mitigating risk when creating a forecast is to give it a serious reality check, what I like to call a “smell test”.
You’ve created assumptions about profitability, the timing of collecting accounts receivable, inventory, accounts payable, capital expenditures, borrowing or payments on debt, distributions to owners, and a number of other important drivers of financial results.
Remember, when forecasting or projecting a full set of financial statements, the real bottom line is cash. So take a hard look at the resulting cash balances for each of the forecast months, and look at both the numbers and a graph of the resulting cash balances.
Creating a Brighter Future for Your Business
A reliable financial forecast can play a huge role in your journey to financial success in business. It will help you:
- Define where your company is going financially (and where you want it to go)
- Expose the danger and opportunities that lie ahead
- Create a road map to get you there safely and on time
- Monitor the pace and progress on the journey to financial success
Best of all, it is a surprisingly effective tool in helping you increase profitability and improve your cash flow.
And it all starts with a reliable financial forecast.
NOTE: If you would like to go deeper and implement a financial forecast in your company, take a look at the Free Rapid Learning Guide below. The guide is titled Financial Forecasting for Serious-Minded Entrepreneurs (and CFOs). It’s your step-by-step guide to implementing a reliable and repeatable financial forecast. And it’s FREE. You can download it in the free membership area.
Philip Campbell is a CPA, financial consultant, and author of the book Never Run Out of Cash: The 10 Cash Flow Rules You Can’t Afford to Ignore. He is also the author of a number of online courses including Understanding Your Cash Flow – In Less Than 10 Minutes. His books, articles, blog and online courses provide an easy-to-understand, step-by-step guide for entrepreneurs and business owners who want to win financially in business.
Philip’s 30 year career includes the acquisition or sale of 33 companies (and counting) and an IPO on the New York Stock Exchange. He helps put the structure and tools in place so the financial side of your business is strong and provides the insights you need to make money, improve cash flow, and grow your business successfully.
This free Rapid Learning Guide dives deeper into the unique and exciting benefits that financial forecasting can unlock for you, your company, and your career. This guide teaches you the step-by-step process for Planning, Creating, and Presenting a reliable (and repeatable) financial forecast.
No more worrying and wondering about what’s likely to happen financially. Now you can create a simple and effective tool for shining the light on where your business is going financially.
It will become your “tsunami warning” system to help you see problems before they happen. You will learn the 2-minute summary – a simple way to communicate the results of your forecast.
And I will go into more detail on the 5 rules for creating a forecast you can trust… and a lot more.
This guide is the “here’s exactly how you do it” resource for the entrepreneur or business owner serious about taking their business to the next level.
It’s perfect for the person focused on creating financial health, wealth, and freedom in their business.