Making financial forecasts can be pleasant and easy, even fun, when a clear, simple and scheduled process is utilized. Financial planning includes budgets and forecasts, which both are important and represent a different viewpoint on the future of the company. Budgets are used in setting the goals for the business, and forecasts monitor their implementation in a realistic way.
Both require a certain preparation process, which is perhaps not often thought of as a process. However, I am ready to claim that understanding this process and the interaction of its parts makes the implementation simpler and more pleasant than is generally thought to be possible.
The forecasting process can be described as follows:
Systematization leads to ease
Most of the information and calculations for different stages are generated automatically, either monthly or weekly. Even though it appears that there are many stages, in most cases only an inspection carried out by the right persons according to a predetermined schedule is required. It is beneficial to view trends next to the calculated information, and enhance the forecast based on them when necessary. This means that the time consumed in the process is short, and reviewing the forecast does not require time needed for other tasks.
Cooperation leads to a broad outlook
A broad outlook facilitates understanding and reviewing of a forecast. In practice, I have noticed that reviewing the forecasts together is a very effective form of cooperation. It allows experiencing the shared goal first-hand, and at the same time, hopefully finding shared methods for achieving it. For example, when reviewing a sales forecast, a decreasing trend is noticed together, it is great to see everyone trying together to find ways to reverse the trend. I firmly believe that this has a positive effect on group work in other functions of the company as well.
The forecast model should be simple enough. The goal should always be that the current situation and the conclusion of the forecast can be seen with one look. Of all things, this has perhaps the greatest effect on the time required, and even one hour monthly can be enough. Simplicity goes hand in hand with essentiality. If very detailed forecasts are attempted, the time requirements would be immense.
A three month rolling sales and profit forecast provides a good outlook on the future. In practice, the forecast of the previous month is reviewed, and a new month is added after the previous ones. It is important to analyse the differences of the previous month’s actual figures and the forecasted data, since this improves the realism of the forecasts through experience.
First a sales forecast is made, since it provides all the essential information needed for the profit forecast. The profit forecast in turn provides information used in the automatically calculated balance forecast and cash flow forecast, which are compiled for the same period of three months, but on a week level.
Basic information used in forecasts
The actuals and compiled budgets form the basis of the forecasts. The outcome data is received directly from financial systems, and budgeting can be done easily using same forecasting process, by slightly changing the viewpoint and timeframe. When the forecasting is started, budget figures are first updated, and later forecast figures of previous months combined with the budget figures are updated.
The following is an example of profit forecast being reviewed:
Here, green months are the ones being forecasted. The whole financial period can be presented, so that the rest of the months are represented by budget figures. Also, those can be forecasted when necessary. For example, when a big project is moved 2-3 months forward, it is necessary to update the changes also to the period exceeding three months.
All starts with forecasting sales. The starting points for this are different in different lines of business. In some businesses engaged in trade of goods, turnover is equal to sales. Often however, the closing of a sale, i.e. the receipt of an order, is at different time from the delivery of the sold goods. Sales forecast is based on budget, i.e. the set goal, and the estimate of the sales personnel on the degree of realization. At that time, an estimate of margins on sales and delivery times is usually ready. Based on these it is possible to calculate turnover, variable costs and sales margin into the profit forecast.
Trends help in seeing the right direction for the forecast. It is especially important to analyse sales trends.
Balance and cash flow forecast side by side
A 12 weeks’ rolling cash flow forecast can for the most part be calculated automatically using the data from profit and balance forecasts. However, a balance forecast includes cash reserves obtained from cash flow forecast. Cash management has an increasingly important role in companies, as has the forecasting of cash reserves (12 weeks’ rolling cash flow forecast). In some forecasting software, balance forecast is matched using the cash reserves, which leaves the effect of cash reserves completely unaccounted for.
Using the turnover rates calculated from actuals, payments to the cash reserves can be included in the cash flow forecast. Exceptions to this include receivables falling under a factoring agreement and project instalments. Due accounts payable can also be calculated using turnover rates.
Monthly forecast provides experience and routine
Rolling forecasting done monthly helps in accumulating experience quickly and easily. This means more realistic forecasts and less time used for compiling them. I recommend that forecasts are made together, which provides more outlook into the forecast process. It is often thought that forecasting should be done by financial management personnel. However, only the compiling of the information can be considered their job.
Financial forecasting is pleasant, when it is done in cooperation and using a systematic, simple process. The forecasts are an absolute necessity to responsible persons and company management for making quick decisions and predicting the direction of operations, and they help the company in succeeding also in a changing business environment. Contact us if you require help in developing the forecasting process. We are glad to help.