This may come as a surprise. Our target market companies are making anywhere up to $25+ million in revenue per year and a lot of them still do not forecast. It is one of the reasons we can offer something unique to our clients. We see their financials as part of a bigger picture: Their success. That can mean different things to different companies. Some are planning on diversifying or shifting business models, some are wanting to scale and some are looking to exit, and all need the forecasting to do it successfully.
Why do business owners need to understand how to forecast?
If you have been part of a budgeting roundtable with me, or if you have read my last post, you are familiar with my race car analogy. Think of your business like a race car: If you are only looking in the rearview mirror (i.e., using historical financials), you are not likely going to win any races. Ultimately, forecasting is about taking a proactive approach to your business:
It provides the chance to plan for both supply and demand needs.
Understanding when and how a new hire might affect cash flow.
It is essential in introducing a new service or product.
Three steps to nail forecasting for your business
Budgeting and forecasting should go hand in hand. A budget is what you create one time for the year and you never change it. It is your stake in the ground. Your forecast is driven by your budget and without it, you would not be able to accurately forecast.
Create Your Budget/Forecast Just the process of creating a budget and a regular forecast holds incredible value. It forces your team to sit down and think about what is in the pipeline for your company. Going through the budgeting process provides a deliberate time to strategize without getting sidetracked by the daily undertakings. It gives your team the space to really think about how you’re going to hit the targets you set. Those goals are great, but only if you have a tangible strategy in place for how you plan to achieve them (e.g., here’s how we plan to hit x number of customers by this date). You are likely going to be wrong, but it’s not about having a perfect forecast, it is about creating valuable conversation.
Begin by discussing your key assumptions based on the cash flow you expect, then nail down your costs and drivers. Be clear about the purpose of the forecast and how it will be used. The best practices we have seen through this process:
Link your expenses to revenue and know your growth ratios (e.g., hire one person for every four new clients);
Bridge your daily operations to your long-term financial goals (e.g., digital cost-per-action, daily prospect touches by your sales team, customer usage frequency, etc.).
Reviewing Your Budget/Forecast Stripping away all the jargon, your forecast is essentially taking your budget multiple times a year (monthly, quarterly, etc.) and updating it. The faster your company is growing, the more often you are forced to update it. Again, each time this happens, your team should sit down together and think about the future of your business, its growth and how to plan for it. The goal of reviewing your forecast is to create strategic conversation.
If you look only at the P&L on the left, it looks pretty good with a 10% increase in net operating income. But, if you compare it to your stake in the ground—the budget—you see this business spent the same amount on personnel and ended up with half the amount of income they expected. They spent more on product than budgeted and then cut down on personnel just to show a profit. That is the exact opposite of positioning yourself to grow.
Some inaccuracy in forecasting is expected; however, if you are way off, it forces you to ask questions: Why are we not we hitting the revenue goals we set? Do we need to shorten sales cycles, raise or lower prices, automate tasks etc.? This review process forces dialogue with your marketing or sales teams and various other departments.
Changing Your Budget/Forecast By reviewing your forecast and monitoring operational metrics, you can adjust to the needs of your growth plan. Compare actuals to budget and forecast to budget, then revise assumptions or tighten up operations as needed.
The point of your forecast is to drive a forward-looking approach and drive change through daily or weekly review. However, it needs to be a tangible, daily goal (e.g., the sales team should call 50 people each day). If you are only using monthly financials, then you will always have a lag in response.