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 unbiased, reality-based expectation of financial results that is designed for decision-making (not precision).
By “financial forecast,” I’m referring to a full set of forward-looking financial statements (income statement, balance sheet, and cash flows) that includes a 2-minute summary.
Too many entrepreneurs and CEOs today are feeling more like passengers than drivers in their business. They’re staring at their rearview mirror as they bounce along in the passenger seat. Their company is careening along on the highway of business as they wonder and worry about where their business might end up financially.
A reliable financial forecast solves this problem by providing a clear view through the financial windshield of your business. It creates the visibility and clarity you need to drive your company toward a bigger and brighter financial future. Put yourself in the driver’s seat of your business by tapping into the unique and exciting benefits that financial forecasting can unlock for you.
A Quick Start Guide to Financial Forecasting, will help you create the view through the financial windshield of your business. Learn more here.
The Monthly Financial Rhythm
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 cycle continues every month by making any necessary changes to the financial goals and targets and the resulting forecast/expectations. It’s a Monthly Financial Rhythm designed to help you focus on what matters most. It’s the key to turning financial information into insight… and improved profitability and cash flow.
10 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 summarized version of the 10 rules 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 better business decisions. (Here, precision is your enemy.)
As you create and use forecasts and projections, think decision-making, not precision.
Forecasting Rule No. 2: Think Top-Down, not Bottom-Up. Forecasting uses big-picture drivers and assumptions to create a model of what the financial statements may look like based on existing trends and plans. You have to take yourself up to the 30,000-foot level and look down on the business financially as you forecast.
It’s about painting a picture of what the financial results will likely be based on your knowledge and intuition rather than actual transactions. Your forecast looks at the strategic view and direction of where the company is going—not the nitty-gritty bottom-up details.
Forecasting Rule No. 3: Model a Full Set of Financial Statements. A reliable financial forecast is 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 six to eighteen months.
Forecasting Rule No. 4: First Look Back, Then Look Forward. One of the biggest mistakes entrepreneurs (and CFOs) make in creating a forecast is to start with a clean slate. They pull up a blank spreadsheet and begin thinking about what the first month in the forecast will look like. The problem is you unhook your forecast from reality when you do that.
The first step should be to drop in actual results for the last six to eighteen months (or more). Have the revenues and expenses been coming in the way you expected them to? Can you see a trend developing? Are you surprised by any of the numbers now that you are looking at the last six to eighteen months of actual results next to each other?
Once you have a good view of what the financial results have been over the last six to eighteen months, you want to look at some of the factors that can make the next six to eighteen months vary from the historical results. That could include things like seasonality, a change in service or product mix, whether you will be expanding geographically, etc.
Forecasting Rule No. 5: Understand the High-Level Company Strategy and Expectations. One of the benefits of forecasting is that it forces you to think about your company’s vision and strategy more deeply. For example, what are the three most critical goals or initiatives for the coming year? Is the company planning to grow slowly or aggressively? Are there plans to move into new markets or attempt to attract new customer segments?
Answering these types of strategic questions forces you to step back and think about the big picture. If you have a CFO it helps him or her “get out of the ledger” and talk to management about their division’s goals or their department’s strategies. It requires you to talk to your board and trusted advisors to get their input and perspective.
Forecasting Rule No. 6: Simplify, Simplify, Simplify. One of my favorite quotes, known as Meyer’s Law, says: “It’s a simple matter to make things complex, but a complex matter to make things simple.”
You will be surprised how difficult this advice is to implement once you begin creating, and regularly updating, your financial forecast. The number of potential rabbit holes you can dive into while forecasting is huge. With all the assumptions you have to make in creating your forecast, it is very important to think about one of the more counterintuitive facts about forecasting: The more detail you bring into the forecasting process, the more error you will create.
The key to success in forecasting is to be always thinking about how to simplify, simplify, simplify…and simplify some more. Simplify the key drivers, critical assumptions, and how you interpret and present the results of the forecast.
Forecasting Rule No. 7: Create a Repeatable Process. Because your forecast will be updated with actual results and the forecast adjusted every month based on current information, repeatability is very important to the forecasting process.
The software tool you choose will impact the success of your forecasting process. The tool must include the underlying logic for forecasting (modeling) a full set of financial statements and perform a number of additional functions. (Chapter 6 in my book A Quick Start Guide to Financial Forecasting is titled Choosing Your Software Tool–Spreadsheets vs. Forecasting Software. This chapter helps you evaluate the pluses and minuses of spreadsheets vs. software tools).
Forecasting Rule No. 8: Be Conservative. Because we know a forecast will not be perfectly accurate, the challenge is keeping it in the “ballpark” as a wildly inaccurate forecast will hurt your credibility. You do that by being conservative in your key assumptions.
It’s like meeting someone for lunch. You agree to meet a good friend at a restaurant at noon. You set noon as the time to meet so you will both be there at about the same time. But despite the precise time you set, you know that both of you will not show up at exactly noon. The only question is whether you will be there a little before noon or a little after noon. Will you be early or will you be late?
It’s the same for your forecast. Your estimates will not be perfectly accurate. You want to err on the side of being conservative. That way the surprises are pleasant rather than unpleasant.
Forecasting Rule No. 9: Condense the Results to a 2-Minute Summary. Creating a reliable forecast and effectively communicating it to your audience starts with making the forecast results simple and easy to understand. Here is a helpful exercise that works especially well when implementing a forecast process for the first time.
Imagine you will sit down with your board tomorrow morning. In that meeting, you will have two minutes to convey the essence of the forecast (key insights, implications, and assumptions) to him or her. That person will then step into another meeting with the company’s key shareholders and lenders to share his or her insight about where the company is going financially. Your mission: Ensure they can share the insights from the forecast with confidence and clarity.
This exercise will force you to distill the insights and implications of the forecast down to what matters most so that you can clearly identify and communicate the most important high-level drivers and assumptions.
Forecasting Rule No. 10: Start for Your Eyes Only. As you make progress in creating your forecast, it’s natural to want to begin sharing it immediately. However, keep it “for your eyes only”—at least to start.
That means don’t sell your leadership team on the value of having a forecast, don’t talk to them about the assumptions or specifics as you create the forecast, and don’t send the results of the forecast to them—yet.
Instead, spend a few months “beta testing” your forecast to learn from and experiment with the process before rolling it out to the management team or the board. Create assumptions at the highest level possible to prove to yourself that you don’t need to forecast at the detail level. Create the forecast for the next three months, then com- pare the actual results each month. What worked out well? Are you surprised at the difference between your forecast and the actual results?
After running the forecast process for three months, you will become more confident and knowledgeable about the benefits of forecasting and how best to create and present the results. You will learn firsthand where the landmines are to avoid. You will develop a better sense of the kinds of monthly and strategic decisions that the forecast can help you answer and influence.
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. 🙂
Philip Campbell is a CPA, financial consultant, and author of the book A Quick Start Guide to Financial Forecasting: Discover the Secret to Driving Growth, Profitability, and Cash Flow and 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 create financial health, wealth, and freedom 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.
This book provides a straightforward, easy-to-understand guide to one of the most powerful financial tools in business: a reliable financial forecast. It will transform the financial future of your company and help you make better, faster, smarter financial decisions.
Too many entrepreneurs and CEOs today are feeling more like passengers than drivers in their business. They’re staring at their rearview mirror as they bounce along in the passenger seat. Their company is careening along on the highway of business as they wonder and worry about where their business might end up financially.
A reliable financial forecast solves this problem by providing a clear view through the financial windshield of your business. It creates the visibility and clarity you need to drive your company toward a bigger and brighter financial future.
What if you had answers to questions like:
What’s about to happen to my profitability and cash flow?
How much cash can we distribute to the owners of the business?
How long will it take to pay off our debt?
What will our taxable income be this year?
A reliable financial forecast puts the answers to these questions at your fingertips. It helps you take control of your profitability and cash flow because it gives you answers to the most important financial questions you have to deal with every day.
Put yourself in the driver’s seat of your business by tapping into the unique and exciting benefits that financial forecasting can unlock for you.
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