Does your company struggle with liquidity issues? If so, experts say there’s a good chance you need to spend more time on financial forecasting. Many argue there’s a strong causal relationship between accurately planning your finances and enjoying a healthy level of cash flow.
“Effective financial forecasting is an integral part of a company’s risk assessment process; if you haven’t identified the risks impacting the business and their potential economic impact, then there’s a gaping hole that could lead to dramatic swings in financial performance and liquidity,” says Meshginpoosh, director in charge of the Audit & Accounting Group at Kreischer Miller. “In a difficult or unstable economic environment, effective financial forecasting can mean the difference between building a thriving business and suffering an economic calamity.”
So what’s the difference between financial forecasting – which almost every company does – and effective financial forecasting, which considerably fewer companies get right? Here’s some wisdom from a few seasoned practitioners about what the latter involves.
Effective financial forecasting involves understanding your company’s key performance indicators, and using them
“The metrics that are used to drive the forecast should be the same metrics that senior management uses to monitor ongoing performance and the same metrics that business unit managers are held responsible for managing,” Meshginpoosh said in an interview with sbonline.com. So, if your company incentivises your staff to sell with higher margins, then your financial forecasting should include anticipations about margins. If you’re trying to drive customer retention, make this a factor in your financial forecasting.
Effective financial forecasting involves integrating across departments
“Financial forecasting will never be accurate if it is developed independently of other forecasts,” says business writer Stephen G. Lynch on finance.toolbox.com. “Line items in the financial forecast should have direct ties to forecasts and assumptions made by sales and operations. All groups should be using a common set of drivers and assumptions regarding the economic outlook and the expected demand for the company’s products or services.”
Lynch’s point is a salient one. If the sales and marketing team is working on the assumption that the market is robust and willing, while the finance department is working on the belief that consumers are losing confidence and retreating, there will be a strategic disconnect between the two, leading to inaccurate forecasting and conflict later in the financial year.
Effective financial forecasting is simple
Tomasz Popiel, a business correspondent for QuickBooks, suggests an uncomplicated path of action. “When starting out, keep things simple. Look at your core business and show the path to profitability,” Popiel says. “If things aren’t looking good, take some time to re-evaluate your drivers and make decisions that will help increase profitability.” Lynch agrees, saying most companies could benefit by “dramatically reducing the level of detail” in their financial planning. “Every forecast should minimize the level of detail needed to forecast revenue and profitability,” he says. “Attention should be paid to those key line items that drive changes in the forecast.”
Effective financial forecasting is adjusted frequently
Financial forecasting is an ongoing process which involves frequent reflection and adjustment. This year’s economic performance in South Africa is a perfect example of how difficult it is to predict exactly where trends will take your company. Economic growth has been markedly lower than expected, and businesses have had to regroup and pare down their sales expectations. Do this activity often to ensure your forecast remains relevant.
If your company needs assistance in developing effective financial forecasts, contact The Finance Team. Our associates are qualified, experienced professionals who can provide your company with the level of expertise for the time that you need it and no more.