Staying on Point - Forecasting
Some time ago (too long ago!) we discussed risk and how it relates to small businesses. The simple take away being that most entrepreneurs take on too much risk, getting them into trouble far more often than necessary, and creating a very high failure rate for small businesses over time.
Uhm... oh yeah... and Happy New Year?!
New Year, New You... What About Your Business?
Obviously risk isn't always a recipe for disaster, in fact, taking risk is a healthy part of any business. When properly measured, it is often what helps drive a businesses to success. So how does one turn risk from a negative to a positive?
At the beginning of each year, we spend a lot of time introspecting on ourselves... things we can improve, what we want to achieve, stuff we want to do. We then create New Year's resolutions and set out to achieve those aims over the course of the next year.
One key to running a successful business is to simply do the same thing within your company. Sit back at a high level, speak to your employees and stakeholders, take stock of your situation. Make plans to advance and better your business (i.e. take a risk or two). Then do it.
Yeah... Because It's That Easy
Most entrepreneurs don't have a problem with this simple concept... let's face it, drive is an integral part of any small business owner's personality. They like new shiny things and the idea of success (and hence, will try anything to get it). Yet, most small business owners get derailed because:
- Their ideas are not rooted in financial reality (akin to trying to lose 50 lbs in 2 days).
- They can't focus or "stay the course" (akin to "cheating" the odd day... which slowly turns into every day).
- They don't know if they are even "on the course" (akin to losing weight without tracking it or without accountability... it's possible, but not as easy).
This is where forecasting and budgeting come in. Just like that amazing fitness coach you love to hate will help you get in shape, a good forecast/budget will help you execute risky decisions properly and within your means.
5 Keys To Forecasting
So what are some keys to forecasting?
- Base the forecast on your current reality. Ensure your accounting system is up to date and fully reconciled, then use it as a starting point. This is a simple but important task. If your system is out of date, your budget will be based on bad data (garbage in, garbage out!). Ask questions like:
- What does your financial past look like? Sometimes this isn't what business owners expect (maybe revenues are lower than expected, a lot of times expenses are higher than expected).
- What does your current cash position look like? This will come into play to help finance those risks.
- What does your working capital look like? This will also determine if you can finance those risky plans to world domination (i.e. if you have more AP than AR... expect to have less cash at some point in the future!).
- What does your financing look like? Can you expand it, or do you need to contract it in conjunction with your plans?
- Build your forecast on your future expectations and using past financial metrics:
- How quickly do you collect on your invoices? (this impacts cash coming in)
- How quickly do you pay your bills? (this impacts cash going out)
- What are the costs associated with your plans? Detail these as much as you can for obvious reasons. But don't get too carried away, try to KISS so you can actually wrap your head around any budget you make.
- Where is the money for your plans coming from? Is your financing coming from the cash your business is generating, or from other sources like bank debt.
- Map out your budget over a granular time frame:
- It is beneficial to have a budget broken out monthly so that you can see when your cash resources are getting too tight... or too high (wouldn't that be nice!). If you simply clump everything into years, you might miss out on important cash events that will cause undue stress.
- Review your budget with other people:
- It always helps to review your work with other stakeholders (key employees, investors, bankers, etc.) to see if your plans are sound, or might have some unintended consequences. There are always a lot of variables at play, which is hard for one person to encapsulate in every single way.
- Compare your actual performance to your forecast:
- Once your forecast is in place and your plans are underway, compare your actual performance to your budget. Are your revenues trending as expected? If not, do you need to adjust anything? Are your expenses in line? If not, why?
- Review your budget frequently (likely monthly). Did you have any unexpected cash outlays? If so, how does this impact your overall plan? Quite often people assume that budgets happen once per year and are "locked in". The forecasting process should really be dynamic, with significant changes in real life leading to a revised budget and update plan of attack.
- Reconcile and close your accounting data properly as part of this process. Much like at the outset of creating your budget, garbage in equals garbage out. If you have bills that aren't entered, or missing revenue, comparison of actual data to your forecast becomes meaningless.
Forecasting and budgeting isn't easy. But once tackled, it is an indispensable tool that every small business and startup should have. With proper financial planning wrapped around business decisions, risks turn into well planned opportunities.
At Twenty Eighty we love to help. As part time CFOs, part time controllers and small business accountants, it's our M.O. to analyze, assess, educate, and bring our clients from a point of "you don't know what you don't know" to a place of harmony within their small business (financial, accounting and otherwise). We believe that business planning and strategy execution is key, so "Staying On Point" is a blog series aimed at highlighting issues that small business owners face, and providing learning points in that regard (and hopefully spurring some discussion from our community as a whole as part of the process!).