Business Forecasts – Why do I need them?
Here at Advivo Accountants and Advisors, we’re always preaching about the importance of having a functional business forecast or budget. “Why do I need a business forecast” I hear you ask? The short answer is “because you can’t afford not to”.
Everyone has heard the phrase “you can’t change what you don’t measure” and it’s true! This is because without that baseline measurement, you’ve got nothing to compare results to. What’s more, if you’re trying to measure the outcome of certain decisions, whether they be marketing, staffing, or general business strategies, you have no way of knowing what’s working or what’s not unless you have a baseline against which to measure results. Your business forecast gives you that baseline.
Why else are business forecasts and budgets important?
I’ve already briefly touched on the importance of measurement and below are just a few of the many additional reasons why business forecasts and budgets are important.
- Banks – Banks will often request forecasts when assessing a business’ suitability for finance
- Goal setting – Setting goals and targets for your business and team;
- Morale – Those within organisations should know they’re part of something bigger and visibility on organisational goals and targets (which come from forecasts) help set team and individual targets keeping everyone’s head in the game, working towards your common goals;
- Business Improvement – Forecasts help owners understand where things went wrong (i.e. ask the question as to why you were over/under budget);
- Growth – Even if you’re comfortable with the size of your business, these days if you’re not going forwards, you’re going backwards, so it’s important to continuously be planning for a certain level of growth within your business.
How do I start forecasting? Looking back to look forward.
It’s actually quite easy to get started, which brings us to another common phrase “How do you know where you’re going if you don’t know where you’ve been?”
As I write this, 30 June has just passed which means for many it’s the perfect time for you to look back at the last 12 months and assess how you went. Do you actually know or are you just guessing by the ‘general feel’? Are you happy with your results? Why/why not? The only reason you should be happy with your results is if you had something to measure them against.
A good place to start for setting a future budget or forecast is looking at the previous 12months financial statements and asking yourself several questions:
- Am I happy with those results?
- Am I planning to do anything different for the next 12 months?
- What outcome do I want to achieve in the next 12 months?
The outcome you want to achieve is what forms the basis of your forecast. This essentially forms the top line figure that you want to aim for (i.e. your sales target or budget). I always break it up into 12 monthly targets for tracking purposes.
A Business Forecast or Budget can be simple.
A business forecast or budget doesn’t necessarily need to be complicated. In some circumstances it may be appropriate to just take your previous year’s result, increase the top line by a growth percentage, and call it done! Whilst this isn’t exactly a ‘detailed’ forecast, it will give you something to aim for over the next 12 months.
Just a little more detail goes a long way.
It’s really only smaller businesses such as sole operators who can get away with a forecast or budget being as simple as that described above. As your business increases in size, so too do its requirements. Most forecasts should therefore at least have their cost of goods sold (COGS) moving appropriately with their sales. You can work out your COGS as a percentage of sales based on your historical figures, then use that percentage to estimate what your COGS will need to be in order to reach your forecast (or budget) level of sales.
Take this a step further again to add in your overheads (being all your fixed costs, like rent, insurance, outgoings etc.) and you’ll end up having forecasted your net profit as well. This then lets you know what’s left after tax etc. so you can plan for that holiday (run with the excitement… it’s free!). Importantly, just as you get excited about seeing possible results, so too will your staff, so you’ll actually be more likely to achieve those targets just by having your staff aware of them.
A Business Forecast is not just a number…
Whilst most overheads will be fixed to an extent, there will come a time when your business needs to add to its overheads so as to be able to deliver the level of sales forecasted. This is when your forecast really comes into its own.
When businesses have growth plans, I recommend making sure your forecast/budget isn’t just a static document, but more of a financial model which can be used to forecast not only your expected profit, but also your balance sheet and most importantly your cash flow! This lets you clearly identify timing of when you’ll need additional resources to facilitate your business’ growth.
‘Resources’ required could include staffing (which will increase employment costs), a larger business premises (which will increase rent and outgoings) and so on. Most importantly, cash is a resource which you need to plan for. This type of budget is typically referred to as a Three Way Forecast and we’re finding more and more financial institutions are requesting such forecasts so as to determine a business’s capacity to borrow funds.
Any accounting software worth what you are paying for it these days will let you input “Budget” figures into it month-by-month (for at least the Profit & Loss component). So get these figures from your forecast into your accounting software budget so that each month you can run an Actual vs Budget report to very easily see how you went against your forecast and review any areas that are not going according to plan so that you can try and keep on track towards your target.
A Step further again:
Just as many lenders are now requiring Three Way Forecasts to assist in their decision-making, business owners can take their own forecasts a step further, turning them into fully functioning financial models. This allows you to run ‘What-if’ scenarios on your business because you’ll be able to model the impact of business decisions to help you assess their pros and cons, along with any associated cash flow implications. Cash is king, and many good businesses have failed due to poor cash flow. A fully functioning financial model allows you to forecast the cash position for your business, meaning you can step in and address any problems before they become an issue, and you can forecast for realistic goals, with a proper understanding of the resources required to achieve them.
This kind of detail and understanding is imperative if your growth plan involves debt funding.
Does size matter?
A forecast should be tailored to whatever your requirements are. The size of your business doesn’t matter, it’s more the information you want to use from your forecast which determines how simple or complex it needs be. This means there are no excuses for not having some form of a forecast for your business.
Horses for courses
If you’re not a numbers person, but you understand the importance of business forecasting, there’s no need to bog yourself down trying to figure out how to do it or what’s best for you. Most times, what’s best for you will be to focus on doing what you do best and simply talking to your accountant or advisor so they can steer you in the right direction. It doesn’t have to be expensive, often a simple business forecast can provide the guidance and clarity you’re after and by making it visible to your staff, along with measuring how your ‘actual’ results track against your budgeted or forecast results will allow you to make better business decisions and you’ll be surprised at the effect it has on morale, creating a joint sense of achievement for your team.