Financial Forecasting —
It’s All About Teamwork

Every company has planned business activities to some degree – even if the plan is not committed to paper. However, getting it down in black and white formalizes the process and instils a discipline upon the corporation; it forces action and involvement at all levels of the company.

Preparing a financial forecast represents a unique opportunity for a company: the process articulates the vision of all levels of management, and adds real-world input from bankers, accountants, and outside advisors. A well-prepared forecast reflects your views, tempers it with reality, and tells you where you’re going and how to get there.

There are two key types of financial forecasts: strategic planning vs. operational. Strategic planning is a consultative process that asks the questions about the direction your company will take in the future. The process helps define your corporate culture: asking for opinions and providing feedback is enormously empowering for employees. It encourages entrepreneurial spirit, promotes innovative thinking, and creates synergy which has an immediate, dramatic effect on the day-to-day operation of your business.

Operational budgets attack the nuts and bolts of how to get where you’ve decided you’re going. The discipline of putting dollars against projects is the essence of sensible management. Allocating working capital shines a harsh light on your ideas. The operational budget includes plans for people, marketing, production (if you’re a manufacturer), capital expenses, sales revenues and expenses.

The financial plan ties the whole thing together. Here you’re looking at forecasted monthly balance sheets, departmental operating statements, overhead schedules, income statements, monthly cash flows, working capital, and available bank credit. Supporting your financial plan should be details and commentary for sales, expenses and capital costs.

Getting Started: Looking down the road

The strategic plan for the company is the starting point in any budgeting process. Where is the company headed during the next five years? Where are the markets? The growth opportunities? What products will be in demand? What do you want to accomplish between now and then? This exercise involves creative thinking, but not wishful thinking – the long range objectives must be realistic. They serve as the foundation for the company’s shorter range annual planning. Long-range goals, once set, should be reviewed and restated annually. What are the new factors to consider? What happened during the last year? What are the new opportunities and threats the company should be considering?

The next step in the planning exercise follows hard on the heels of long-range goal setting: An assessment of the company’s current strengths and weaknesses. What are the things the company does well, and what are the areas that need improvement? There is little point in building a plan on a weak foundation; weaknesses should be identified and corrective action implemented. Some hard decisions may be required.

In evaluating strengths and weaknesses, some key questions include:

  • Your profitability – compare your results to statistics provided by your company’s trade association or Statistics Canada. What are your profit trends? What are your profit objectives?
  • Your market – where do you stand? What is your market? Who are your competitors? What do you know about them? Are you highly dependent on a few customers? How do you sell?
  • Your personnel – evaluate the strengths and weaknesses of your key people. Do you have a staff development program? What does your organization chart look like? Are the right people in place?
  • Your productivity – are you as competitive as you should be? How strong is your purchasing?
  • Your finances – do you have the working capital to increase your business? Do you have a cash management program in place?
  • What are your accounts receivable days outstanding? What are your banking policies? Here’s an exercise you’ll find useful in evaluating your organization.
  • Ask yourself “If my sales doubled or tripled next week, what changes would I have to make in my organization?” Consider the impact on your systems and staff in all areas of your company, and especially the impact on your own time.

Corporate Culture

In an ideal setting, each operations manager will prepare his or her department’s budget. They’ll analyze what happened last year, set their objectives for the coming year, evaluate staff members, and prepare their operational budget including requests for capital expenses. If the company is new to budgeting, an initial run involving only the CFO and CEO should be considered if operations managers are not capable of articulating the plan for the coming year.

The most important consideration at this point is getting started. Don’t become side-tracked by trying to have the perfect planning systems in place with all the proper formats and review mechanisms. The act of planning is more important than the mechanics.

Allow about three years to have your planning process functioning smoothly. Implementing a planning system within your organization must take into consideration the capabilities of the managers involved and the time constraints imposed on each.

Your Budget Toolkit

In addition to software, your budget toolkit involves a process to review and update your progress. The reviews should take the form of quarterly meetings and include submissions from each manager comparing the actuals with the budget to date and a recast for the remainder of the year, along with a full year variance.

The meetings will provide a two-way flow of information and a sense of direction to the whole process of managing. In fact, you’ll see management is now driving the operation instead of reacting to it. These operational reviews should be augmented by reviews with your board of directors or advisory board. Your banker and other outside lenders may also require updates on your plans.

Your budgeting software can be purchased as standalone software, spreadsheet models, or built from scratch. Developing your own is time consuming and is a task that seems to never end. Integrating the income statement with balance sheets and cash flows can be tricky and may require an arbitrary entry to balance.

Off-the-shelf budgeting software comes in two flavours: standalone vs. spreadsheet. Good standalone models tend to be rather expensive, in the $25,000 range, and may not include full integration with balance sheets and cash flows. Annual support fees and training costs must also be considered. Spreadsheet models can be purchased for about $1,000 since the developer can use the spreadsheet engine.

Presenting the package

Whichever route you take, here is what bankers and boards of directors are looking for in your forecast:

  • Include a narrative description of last year’s performance along with a narrative description for the coming year. Ensure there is consistency between dollars and descriptions.
  • Narrate the changes in your financial position. A financial statement to this effect should be included.
  • Avoid pie-in-the-sky forecasts. Any knowledgeable person will spot undue optimism, particularly when opening and closing balance sheets are compared.
  • Make sure your numbers are attainable. Budget failures don’t sit well with stakeholders. It can make your advisors look foolish for approving and accepting the numbers.
  • Present a full set of financial statements including the balance sheet and cash flows. Include a ratio analysis. Presenting only the income statement won’t cut it.|
  • If five-year forecasts are presented, include a summary comparing annual balance sheets, income statements, overhead schedules, cash flows and ratios. Have the supporting details available for scrutiny.
  • Be prepared to make revised submissions promptly.

When the presentation is over and the approvals are in place, the financial plan will serve as a reminder of the direction your company has chosen to take.