Forecasting? You’re Doing it Wrong.
A wake-up call for service-based businesses through the insights of a Virtual CFO.
Goal setting has traditionally been based on past performance. This practice has tended to perpetuate the sins of the past.
- Joseph M. Duran
Traditional Forecasting is Dying
Most companies employ a bookkeeper or accountant who looks at past performance to forecast what the company’s next month, quarter, or year will look like.
And that’s fine…but it’s not enough.
A true forecast is more dynamic. It’s updated regularly — think every DAY or WEEK instead of each month or quarter — and it factors in a lot more detail than a traditional forecast.
Your company is dynamic.
From hiring and firing and offering raises and bonuses to bringing on new clients, implementing new software solutions or preparing for an upcoming conference or event, your revenue and expense model is in constant flux.
If you’re a service-based business without an acting CFO who walks through your forecast (at least) on a monthly basis, you’re holding your company back from building a stronger financial foundation. From knowing where you stand re: cash flow and what kind of investments you can make, distributions you can take, etc.
Here’s what I see happen.
Many companies hire someone part-time — usually a wife or husband or friend of an existing employee — to handle bookkeeping. And that can work to a point, but once you have more than say, 10 employees, you need an accountant to help you put together a proper forecast and cash flow on a monthly basis.
And when you get to say, 20 employees, you should employ a part-time Controller or part-time CFO to help you on a weekly basis.
Without a dedicated person looking at your company’s financial health, things can fall apart.
Best practice forecasting should focus on your balance sheet. You should be looking not just at past performance, but how that performance effects your balance sheet in the future.
Huh? A Balance Sheet?
When we say that best practice forecasting will tie your balance sheet together, here’s what we really mean.
A true financial forecast doesn’t just take into account your revenue and expenses. You need to also factor in elements like:
- How much liquid cash will you have 1, 3, 6 and 12 months from now?
- When will your short and long-term debt be paid off?
- Who still owes you money (accounts receivables) and what terms are they paying you back?
- Who you still owe money to (accounts payables) and what terms did you give those vendors?
- Any capital purchases (Cap X) needed in the future?
- Upcoming expenses — an example might be a conference. In your forecast, you shouldn’t spread the expenses over many months when in reality, you may be making big expenses in one or two months like travel, booth sponsorship, and marketing materials.
- Do you have enough money set aside to pay Uncle Sam minimum quartely tax payments and then the difference in April?
Here’s why all this is important.
A cursory glance of your forecast might show that over the last several weeks, you’ve generated a TON of net income. Wahoo! You’re doing well right?
Here’s a scenario we see too often. What if, to generate that new income you just hired a new producer to join your team. Your clients are on net-60 or net-90 terms, where they’re paying you over the course of a few months rather than 100% upfront. Happens all the time. But if you don’t have a proper cash reserve, paying your new employee might become challenging.
And if your clients don’t pay on time, it could get even worse!
It’s the same with your accounts payables. Maybe normally you’re paying a vendor every 15 days, but you might need to stretch that to 30 or 45 days if you anticipate cash flow challenges.
Forecasting with your balance sheet helps you make these constant adjustments and develop a more intimate understanding of what’s happening in your business.
The Bottom Line
The real key to all of this, and something that should be uncovered with stronger forecasting, is understanding how your non-financial KPIs (Key Performance Indicator) impact your revenue so you’re not simply guessing.
Here’s an example:
In a service-based business, if you have 5 producers on your team, you need to know how much revenue they are each expected to generate.
If you don’t know this, then how will you know if you have too many employees? We run into this with our clients all the time!
At the end of the day, financial projections are fun to see on a whiteboard, but what REALLY matters is what’s happening on the ground.
Each an every financial aspect of your business, regularly poked and prodded and put under a microscope to help you better understand your company’s health and financial future.
Want help thinking about your company’s current situation?
Jody Grunden is a nice guy who likes hockey, golf, and his family. He also meets with businesses on a weekly basis as a Founder and Managing Partner over at Summit CPA Group, a Virtual CFO firm that helps growing companies manage (and improve) their finances.