We had set the date for our annual barbecue some two months earlier but as the week approached, the weather forecast started to deteriorate. Heavy rain and 40 mile-an-hour winds were predicted but we had invited close to 50 guests! As the day approached the weather system wasn’t forecast to budge. The day before the barbecue we made the call to cancel (maybe we could have hired a marquee but that’s another story).
On the Saturday we looked to the grey skies and felt caught between wishing the forecast was accurately predicting the torrential downpour, so justifying our decision to cancel, and a natural desire for a fair day. As it turned out – apart from a brief shower around midday – the forecast was miserably inaccurate.
So why bother forecasting when they are so often ‘wrong’? In business we are fans of forecasting and recommend that all of our clients undertake a financial forecast, usually for the year ahead. Why?
For two primary reasons:
- to set targets and think through what needs to happen in the business to reach those targets and;
- to understand what you can afford versus what you want to spend.
We have just been through the process of forecasting the business financials with one of our clients. The forecast is for 2017 so we are well ahead of the game. It is the first time this client has forecast at the level of a full profit and loss with all the revenue drivers and cost items individually assessed. This client already had in place good bookkeeping processes and managed day-to-day cash flow effectively so the step up to this level of forecast was not difficult. The bigger challenge was agreeing what we were setting out to forecast and its purpose.
A forecast means different things to different people. It is also one of a number of words and phrases that gets used in a similar context: forecast, budget, target, predicted outcome, stretch target. For a small to medium sized owner managed business what do you need by way of a forecast to make it valuable and worthwhile doing? Well, it depends.
Here are five reasons why a ‘forecast’ will help you:
- To set yourself some goals or targets for the period ahead. A forecast can be used to set out the financial targets and to understand the implications of achieving a given level of activity in your business.
- To identify the major projects, changes and initiatives that the business will need to undertake. Resources such as people, office space, IT capacity and services from suppliers will need to costed and potentially ordered well in advance. Clarity on the major changes also provides an opportunity to engage your team and work out who is capable or has the potential to lead specific projects.
- To assess whether you will have the money available throughout the year to fund the business. The forecast, or at least its first version, may be wishful thinking. It is one thing believing the market and prospects exist to grow the business, it is another having the financial resources to deliver the growth. The forecast helps predict your cash flow and thereby whether you need to access an overdraft or seek other finance.
- To make a case to another person or organisation. As a follow on from point 3 your forecast may lead you to the conclusion that the growth opportunity is sufficiently attractive to consider external finance. In most cases this will require some formality in an application and presenting a business plan. For example, you might approach your bank for a commercial loan, you might seek investment from a private equity fund, you might look to funding through a Local Enterprise Partnership. In all cases your forecast will be a central part of your story. Likewise, if you are looking for your management team to invest as part of a succession plan or even external investment as part of your exit plan, the forecast is a key statement.
- To enable you to delegate with control. We are all well versed with the apocryphal tales of the owner manager who can’t let go. The core behaviour behind delegation won’t change just because you have a forecast for the business but mapping out the key revenues and costs for the period ahead provides the information to delegate with control. The forecast allows you to set targets, to divide the full plan into constituent parts and to set goals and expectations for each member of your team. Your managers can then have clear and stated targets for costs, revenues, recruitment and so on.
Once you have a forecast is that the job done? Many forecasts and business plans have been developed in great detail only to lurk in the shadows of your bottom drawer or forgotten in a folder of other Excel spreadsheets. If the forecast ‘is bound to be wrong’ isn’t that fate a suitable one anyway?
Our clients are encouraged to use their forecast throughout the year. It sets a baseline for what you had set out to achieve and provides a good reference point to assess progress. It also contains important information such as when the business expects, and could afford, to hire a new member of the team or had planned to increase revenue through price changes.
If you complete a forecast for the calendar year in the prior November you may find that even the earliest months of the forecast year are off target. That doesn’t invalidate the forecast or the process. The value of forecasting is as much in thinking through the assumptions as it is in predicting numbers. Having thought through and taken a view on various aspects of the market, your clients, suppliers and internal costs you are better placed to understand any variations and better armed to make an improved judgement.
A frequent check of actual performance against forecast is a very useful process as is an occasional revision of what you think the year ahead will yield. If you are in a fast moving unpredictable market, by definition your forecasting will be more approximate than in a stable environment.
Furthermore, new opportunities may arise or you may be winning more business than you expected, in which cases your forecast mustn’t act as a constraint but a prior view and target that you are now surpassing – but with the added benefit of understanding the consequences and resource requirements that a revised forecast will show.
Our prediction is that your forecasts will be affected by changes in your market and in the general business climate. You might use your forecast to buy in the food and drink for your guests and you may, unlike us, prepare a contingency plan of having a marquee ready for inclement weather. But as it is your forecast you will know which way the wind is blowing and adjust accordingly.
Contact us to explore this topic in more detail.