Many businesses are preparing to enter a new financial year. As they do it is worth thinking about the importance of the financial forecast.
It’s primary role is to predict whether the business will have enough cash to keep going during the year to come. And, as such, it is a vital source of information for business owners, lenders and investors.
Of course, it must be as accurate as possible. But to be accurate you need to think of forecasting as, not just making financial projections at the start of the year, but as an exercise that you apply all throughout the year.
So, as we approach a new financial year, here are a few tips to help you to forecast as accurately as possible.
1. Forecast revenue, and budget costs.
Start by forecasting revenue. Once you are as clear as you can be about your revenue forecast, you can then budget your costs in order to bring them in line with your revenue.
Many businesses use the words ‘forecast’ and ‘budget’ inter-changeably, but they mean different things. Revenue depends upon factors many of which are out of your control (e.g. the economy). So, a bit like the weather, this is something to be forecasted.
But expenditure lies very much within your control. This is something that you can therefore budget for. And by keeping your expenditure budget in line with your revenue forecast you can exercise control over how much cash you have in the business.
2. When you forecast revenue, use several scenarios.
Imagine you run Mrs Miggins chain of Patisserie and Coffee shops. Your biggest ‘drivers’ of revenue will be the number of people who come into your shops and the amount they purchase. Last year’s footfall figures will be helpful, however they can’t be used in isolation. The local town centre may have changed, you might have a marketing campaign lined up, plus a new on-line service.
So it’s important to think about the ‘sales funnel’ and the ‘social media funnel’. E.g. for sales in the shops:
- Start by researching the size of your realistic market (the number of people who could be in walking distance of one of your shops plus the number of potential customers you are reaching out to with your marketing campaign).
- Estimate the proportion within each group likely to walk into one of your shops.
- Estimate of the likely purchases each group will make and the number of times they might return to repeat the purchase.
And, for the social media funnel, very much the same:
- Start with the size of the on-line audience likely to see your advert;
- Estimate the proportion likely to click to find out more;
- Estimate the proportion of this group likely to purchase.
Taken together, this should bring you to an ‘expected value’ for revenue for the year.
That’s a good start, however, it’s a calculation based upon a series of assumptions, some of which might be overly-optimistic or overly-pessimistic.
So, it is worth listing out all the assumptions that you have made (e.g. the size of each realistic market) and, for each, provide both an optimistic estimate and a pessimistic estimate.
Repeat the forecast calculations using both sets of estimates for each assumption.
You should end up with a range of forecast values. The number at the top of the range represents the most optimistic view of the year ahead. And the number at the bottom, the most pessimistic view. The expected value is still your forecast, but the size of the range indicates how much confidence you can have in that value.
If the range is large, revisit each of the assumptions involved and gather as much intelligence as you can to refine the numbers involved.
3. Create an expenditure budget.
With a revenue forecast in place it should be much easier to predict your expenditure. Firstly, some costs (e.g. product costs) will be closely linked to your drivers of revenue. Others will be relatively fixed, e.g. premises and equipment lease costs.
Start with a budget that reflects the most pessimistic view of the year, and then add to it the additional expenditure required should the year turn out to be better. This will help you plan ahead to delay spending in more discretionary areas should unforeseen circumstances strike and the year turns out to be less favourable than you had hoped.
4. Keep a note of all your assumptions, and check for credibility.
The forecast needs to be maintained as the year progresses. It helps therefore to always keep a note of your assumptions handy, and whenever an unexpected event happens (bad weather, regulation change, transport disruption) check to see whether your assumptions still hold true.
If they don’t, then work through the forecast again, but this time with a revised set of assumptions.
There will also be key ratios that relate to your business, most of them financial in nature. E.g. revenue per square metre, gross margin per customer, stock turnover, mean order quantity.
Once forecast and budget are in place, calculate these ratios for the year ahead and compare them with other businesses within the sector, and with past performance. If they seem to be out of line, check your assumptions once more.
5. Regularly re-evaluate.
Every month or every quarter throughout the year compare your actual revenue and expenditure with your forecast for that point in the year.
If there is a sizeable difference in either revenue or expenditure, either positive or negative, investigate why and be prepared to re-forecast.
This is when the discipline you exercised when creating your first forecast will reap benefits. If the exercise had remained at a very high level and didn’t involve analysis of the drivers of revenue and cost in the business you will find it hard to know what to do when gaps between forecast and actuals emerge.
However, if you have that depth of understanding then differences between the forecast and actuals can be highly instructive. Your existing assumptions might need to be changed. Or you might have experienced events that you hadn’t planned for. Either way you will be equipped to figure out what their impact means for the remainder of the year and you will be able to adjust your expectations accordingly.
In othe words, you will be maintaining a highly relevant and accurate forecast.
Paul is a presenter on the professional development programmes for BPP, CIMA and ICAS on subjects ranging from forecasting analytics and budgeting practice to data visualisation and machine learning. He is also a Business Intelligence specialist providing Management Information and Business Intelligence solutions for organisations across all sectors.
If we can help you to develop your budgeting and forecasting practice, in developing financial models to support your strategic planning, or in making better use of data with which to predict the future, then please contact us:
T: +44 (0)333 8000 825
This is the second in a series of blogs about the dynamic future that lies ahead for Accountants. One that, in the face of technical change, involves becoming increasingly competitive as an Accountant and performing a role that is central to the plans for growth within the businesses that you serve.
This is the rapid and unstoppable growth in Cloud based finance systems. Although they help an Accountant to serve their respective businesses more efficiently and effectively, they are already leaving them with less work to do.
This will, of course, create free time with which to offer other services. But this is a double edged sword if it leads to a large number of people having to compete hard for work within the few areas left unaffected.
However, if Accountants are willing to step beyond the confines of their more traditional services and diversify into new areas, a wealth of opportunity awaits. The areas that matter relate to needs that, for a whole host of reasons, are simply not being fulfilled adequately at present.
They are to do with information, in particular that required to give businesses the competitive edge needed to grow.
In this blog we look at the first step for the Accountant who wants to diversify towards a new set of services, ones that will help them to take a seat dead centre within their business’ plans for growth.
Your perception comes first
It involves changing your perception of your role as an Accountant, and then engaging the business in a new conversation about the role that you can play as intelligence specialist, guide and mentor.
It’s helpful to first put your identity as an Accountant to one side for a moment, and then focus upon what you, as a person, really represent for your business or client. You must use your own words, but expressions relating to ‘trust’, ‘integrity’, ‘advice’, ‘understanding’, ‘reassurance’, and ‘security’ might not look out of place within the list.
The next task is to list the skills that you bring to bear. They will be broad, encompassing both the technical and those required to build and maintain strong and enduring relationships founded upon trust, clarity, openness and integrity.
The final task within this first step, while still forgetting for a moment that you are an Accountant, is to work with the people within the businesses you serve to identify their ambitions for the business. With each one cited, identify the most pressing issues standing in the way of progress – as well as the skills and attributes needed of the person capable of finding a way forward.
Then ask yourself, ‘what is stopping me from being that person?’.
I’m very good at what I do and there’s nothing stopping me
Many of the issues are likely to involve the need for information e.g. about the best way to make gains in price, quality of service, or customer retention. Or the opportunities to make better use of resources.
There will be technical processes required for this sort of work. However, they are easily mastered.
More importantly for you, and for the businesses that you serve, this exercise will demonstrate that the skills and attributes needed to find the way forward are the very same ones that you already exercise, as an Accountant, every single day. In other words, you are already an ideal candidate for the job. And there is nothing to stop you from doing a fabulous job.
Once you are convinced of this you are more than equipped for the next step. This involves convincing people in the business that there is a vital role for you to play. But the moment that you describe this as equipping the business with the right information for better decisions, little convincing will be needed.
The cloud is great, but feet need to be kept on the ground
So, those focusing solely upon mastering the cloud based Finance systems will do well. They will deliver highly efficiency accounting services at a low cost. What is there not to like?
However, to make a real difference to business prosperity, it helps to come down from the Cloud and work with a much a wider portfolio of information sources, most of which are to be found firmly on the ground.
We have launched a service aimed at equipping Business Advisors with everything they need for this role. It includes use of an expanding on-line knowledge base, access to easy to master business intelligence technology, and help and support in developing information. Please see below for more information.
We are working in partnership with: Keen Shay Keen MK Chartered Accountants and Business Advisors in Milton Keynes in the UK who are piloting the service, as well as member organisations within The Biztech Technology Forum also based in Milton Keynes. And we have big amibitions. To change the face of accountancy so that you become the data smart, digitally savvy Business Advisors who can use data to help solve the problems standing in the way of your clients’ ambitions.
Within the next blog we will be looking at the the technical processes involved in developing Business Intelligence. Yes there is some technology to master, but you will be surprised at how much you already know.