Financial forecasting is sometimes described as more art than science. In some ways it is attempting the impossible – projecting your business’s success and failures; the threats it will face and how exactly these will affect your bottom line. It’s a given that your projections will never be completely accurate, but financial forecasting remains a key element of a CFO’s responsibilities, and a crucial aspect of business planning. Apart from its use for internal planning purposes, investors will generally want to take a good look at your financial forecasts before coming onboard.
Through their own process of trial and error, various CFOs and business owners have collected what they deem to be some useful approaches to the art of financial forecasting. Below is a collection of some of their advice, along with ours:
1. Plan for both the best and the worst:
A common approach to financial forecasting is to build a base case filled with conservative forecasts and assumptions. This is a practical starting point. But in South Africa, especially with the barrage of negative business news that has been coming at us for some time now, business leaders have a tendency towards negativity. This is reflected in planning and often in financial forecasting, where CFOs consider it their responsibility to communicate to the rest of the business “just how bad things could be”. Of course, a worst-case scenario is useful and very important. But so too is a best-case scenario, if things turn out unexpectedly rosy. In other words, what you really need is multiple versions of your forecasts.
Ethan Siegel, chief executive of New York-based Orb Audio shared his example with inc.com:
“We try to walk the fine line of making sure we are profitable if the worst case comes true, but also have enough product and staff to support the best case predictions,” he said. The company grew by 30% in 2013: foreign sales of the product were boosted by a weak US dollar. “We never would have guessed that we’d grow that much,” said Siegel. “But because we also planned for best case and built up inventory, we weren’t caught with our pants down.”
In planning for the short term, Siegel scrutinises the month-to-month growth rate from the previous year to predict revenue fluctuations for the coming months.
2. Start with expenses, not revenues:
This advice from Asheesh Advani, CEO of Covestor, an online marketplace for investors, is especially useful for startup businesses where financial forecasting is being undertaken for the first time.
In the startup phase, says, Advani, it’s much easier to forecast expenses than revenues. The same could be said of businesses operating in a highly changeable environment, or one that is quickly evolving.
3. Don’t let your annual financial forecasting go stale:
In uncertain economic times, a once-yearly annual forecast is insufficient, says the co-founder of eco products company Seventh Generation. Hollender says companies should consider pushing their financial forecasting further back into the year, to keep it relevant.
“With our year end in December, we used to do our forecast in August but now have pushed that all the way back to November,” said Hollender.
“And in the past six months, we’ve created a new forecast almost monthly. Creating that many new forecasts can take a lot of time, but sometimes it’s necessary. In the end, you don’t want to run a business off of a forecast you no longer have confidence in.”
4. Don’t wander too far into the future:
Josh Tabin, Technology Practice Manager for VCFO, says that although long range planning has its place, it is limited in usefulness for the application of financial forecasting.
“The challenge is that any forecasts over 18 months into the future have too much variability and volatility to be effective for managing the business.
“I recommend having a three-year forecast for a board of directors and investors, with an 18-month forecast for internal management.”
As you consider how to make these tips relevant to the financial forecasting for your business, you will no doubt need to consider the resources available to you to carry them out.
If you need an extra pair of hands to help you carry out the responsibilities of financial forecasting, The Finance Team has a range of experienced financial professionals who can provide assistance on an interim or ad hoc basis.
Image credit: science clarified