In our last blog, we discussed the first four ideas on how you can improve your forecasting accuracy. Today, we delve into the next four.
Remember, when done well, it provides the business owner with a view of what their finances are going to do next. This helps the business owner make better-informed decisions, and to successfully plan the timing of executing those decisions.
Let’s dig in!
1. Base it on real data
Unless your business is going to change dramatically in the next 12 months, the best place to start is your prior month’s financials. Literally, download a monthly P&L from Xero into Excel, roll it forward and use it as a template to build out from.
Then simply ask the question, what is going to be different from last year? And adjust the forecast accordingly.
For every number in a profit and loss statement, or on a balance sheet, there is an underlying number of things, or hours or people. Drill down into these. Does the forecast stack up when you express it in non-financial terms? How many customers do you need to reach the sales forecast? How many staff can you have for that wages forecast, and can that team deliver on the sales forecast?
Xero is a good source of data for stress testing forecasts, but also are your other systems. Whether it is your cloud based payroll system, sales lead pipeline or job management software, these all contain data that can help improve your forecasting.
2. Don’t stop there
Once you have been through as much data as appropriate, now stress test the hell out of it. What if the market dropped 10%? What if interest rates had a sudden rise? What if you lost that key team member? Put it down for a week, come back to it and look at it again. Do you feel differently about any of the assumptions previously made? Ask someone you trust to review it and provide feedback. The worst thing that will happen by investing more time into it is that you will get a better understanding of your numbers.
3. Expand it
Creating a P&L forecast is a great first step, and this gives the business owner a better idea of their short-term financial future.
But many a profitable business has failed due to running out of cash.
It is important to not only forecast the profit and loss, but to forecast what is going to happen to cash flow and to the balance sheet. This three-way forecasting allows the business owner to see the full view of their future financials, rather than just having one piece of it.
The reality is that the impact of GST, debtors, creditors, capital expenditure, depreciation and table loan interest means that the business owner is unlikely to accurately produce a three-way forecast without some assistance from a finance professional unless they are a finance professional themselves (and even then).
There are some great online tools out there to help with three-way forecasting, but a little bit of knowledge can be a dangerous thing – especially when it comes to forecasting.
4. Use it
A forecast is of no value unless the business decision makers later make use of it and refer back to it. The simple act of reviewing last month’s profit v forecast (at the touch of a button in Xero) can lead to insights and help the business owner steer their ship more clearly.
But as much as a forecast helps a business owner decide what to do next, it also helps them decide when to do things. When to hire that next employee, when to upgrade the company vehicle, when to invest in marketing, when to draw some money out, when to pay taxes etc.
And there you have it. If in doubt, contact your accountant and ask whether they can offer some support or directly add value to your use of forecasting.