I posted 5 Things Every Manager Should Know About Financial Forecasts recently on the Industry Word blog on the SBA (Small Business Administration) community site. If you haven’t joined the community yet, and you’re running a business or starting a business, or thinking about it, the SBA in general and its community site in particular is a pretty good resource.
I received an email overnight that reminds me that people still need a lot of reassurance about financials. Maybe these five points, taken from that earlier post, will help:
1. Forecasts are for business, not truth, or beauty. They are almost never exactly right.
The business value of financial forecasts is about making good decisions. The forecast helps you anticipate business trends, allocate your spending right, and manage the flow of money.
The best forecast is one that helped you run the business by setting useful expectations and guiding the way to cash in the bank, business growth, and profitability (in that order).
What’s most important isn’t what you’d think: it’s not as much about guessing the future correctly as it is about setting up the connections between sales levels, costs, expenses, and cash flow. The forecast won’t be right – we’re humans, guessing the future, so they never are – but if it identifies the key drivers so you can watch plan vs. actual and fine-tune your budgets, then it’s vital to business health.
To test the value of a forecast, tracking the plan vs. actual results is obviously vital. But look deeper than the top line. Did the forecast give you a way to identify where assumptions change? For example, did you see how prices ended up lower or higher than what you thought? Or conversions on the web? Did the forecast give you a way to drill down into the management assumptions?
2. Forecasts don’t take an MBA, CPA, or PhD.
In the 30 or so years I’ve been doing business forecasts, 98 percent of the good forecasts I’ve seen were based on smart people, who know their business, making educated guesses. The sophisticated mathematical models don’t beat knowing the business and making reasonable estimates. That’s especially true for businesses that have past history so they can use that as a starting point.
The most common problem in this area is the amazingly common assumption that if you don’t have the right training you can’t forecast. So what, you have to be a meteorologist to guess the weather? You can also look at the sky, the season of the year, and past patterns – with or without the degree. It’s not econometric modeling or thesis-level research. It’s a collection of interrelated educated guesses.
3. Forecasts get old and rot faster than pumpkins.
Real forecasts aren’t supposed to last longer than a month or so. Well-managed companies run the forecast against plan vs. actual analysis after the close of each month, and there are always changes to be made. That forecast you did last summer? If you haven’t touched it since then, it means you’re not using forecasting to help you manage the business.
4. Forecasts are really about lines, not dots.
I first saw the “lines not dots” phrase from Mark Suster, on his bothsidesofthetable.com blog. A line is change over time, tracked, so you can see the significance. For example, your sales next month mean virtually nothing until you compare them to last month and the same month last year, and to your plan and budget. Your forecast sets the base lines so you can track all those surprises, and make adjustments to correct things as assumptions change. Having the equivalent of two months’ worth of sales in your accounts receivable balance doesn’t mean anything until you figure out whether that’s more or less than it used to be, and why the change occurred.
5. Forecasts are for planning, not accounting.
It’s a natural confusion. Forecasts are normally set up to look almost exactly like accounting statements, so it seems the same. But the difference between planning and accounting is a complete different dimension: accounting starts today and goes backward in time in ever increasing detail, while planning starts today and goes forward in time in ever increasing summary and aggregation.
The good news is that it’s easier to do when you understand it’s a collection of educated guesses and simplifying assumptions. For example, you don’t have to guess what assets you’ll need in 2014 to guess that you’re going to spend some estimated amount of money to buy them all. And you don’t have to know what all those assets will be to guess how much money you’ll be able to take, two years from now, in depreciation.
The key is simplifying assumptions. A forecast has only a few of the most important items, not all the detail in every line. It aggregates and summarizes. ”