How to make financial forecasting essential
4 ideas to turn dread into delight
Blake Oliver, CPA | February/March 2021 Footnote
Editor's note: Updated February 1, 2021
This article is not for you if you love forecasting. If, on the other hand, being asked to create a financial forecast fills you with feelings ranging from discomfort to existential dread, keep on reading!
You might feel this way because forecasting is hard for accountants. As a CPA, I can tell you it’s not something that comes naturally. Accountants prefer certainty. We like dealing in hard numbers. Something we can measure.
Forecasting may seem like the opposite. The task is inherently uncertain because it deals with the future. And the further out we have to forecast, the more uncertain it becomes.
In times of economic uncertainty, it gets even more difficult to forecast accurately. Yet, this is precisely the situation when accurate forecasting and planning becomes more important than ever.
The good news is there are a handful of tried-and-true best practices that can help accountants forecast more accurately. This both increases the value of the work we do while also reducing our own anxiety around forecasting.
Here are four best practices to help you forecast faster and more accurately.
Start with your goals, not last year’s actuals
Let’s start with what not to do.
Absolutely, positively, do not copy last year’s results and then apply a growth percentage to revenue and expenses. This is a poor method of forecasting even in a predictable period of growth, even when based on historical trends. That’s because it falls apart when business models are being disrupted.
What should we do instead? Let’s start with a conversation about goals.
Thinking about goals can be a lot harder than just projecting out revenue and expenses, which is why a lot of companies skip this step. But it’s important not to. Getting the team aligned around a common set of goals helps everyone see the big picture and gives them something inspirational to work toward. It also helps to manage expectations.
You may already have a set of common goals. If not, a brainstorming session can help figure out what they should be. Here’s a list of categories to ponder:
- Revenue
- Growth rate
- Cash on hand
- Expansion to new locations
- Adding new products
- Increasing headcount
Combine financial and nonfinancial metrics in a model
It’s very likely that some of your goals will be financial, and some will not. Many goals are operational or workforce-related, such as new hires or adding locations.
This is why it’s essential that our forecast consider all of our data, not just what’s in the accounting system.
The next step is to work backward from our goals and build a financial model that shows us how to hit those goals by achieving specific metrics, which we call key performance indicators (KPIs). These KPIs may be financial or non-financial in nature.
For example, if our primary goal is to increase year-end cash on hand for an ecommerce business, KPIs that help us achieve this may include marketing spend, website visits, orders shipped, average revenue per order, inventory levels, fulfillment headcount, etc.
By combining these KPIs in a financial model, we can project financial performance based on projected business activity, not only what has happened in the past. This allows us to tweak the business model — or perhaps even reinvent it — to achieve our objectives.
While finance professionals have used spreadsheets to build models for decades, accountants on the cutting edge of technology are leveraging purpose-built financial modeling software.
Until recently, these solutions were too expensive for small businesses, but companies such as Jirav are democratizing technology-enabled planning by building financial modeling software that small- and medium-sized businesses can afford.
Be sure to explore all your technology options and don’t just rely on the same old methods.
Connect your forecast to your budgeting process
A forecast isn’t of much use unless it inspires action. After all, what’s the point of predicting the future if you aren’t going to do anything about it?
That’s why it’s essential that your forecast becomes tightly integrated with the budgeting process.
It’s also why forecasting can’t be done alone. It’s important to involve key stakeholders in the forecasting process so that they agree with the output. Involving department heads, executives and even investors in the annual goal-setting process is a good starting point.
But building consensus doesn’t stop there. Once you’ve built a financial forecast, seek input from your stakeholders on key assumptions in your model.
Ask department managers what they’re planning. Ensure that the revenue model is using the latest targets from the sales team. Ask your head of marketing to validate the lead funnel metrics. Does your operations manager intend to hire in the next 12 months and by when?
Incorporating your departmental managers’ plans into the forecast means that you can convert your forecast into a budget without much trouble at all. That saves time because you’ve combined two processes into one.
Convert your annual forecast into a monthly rolling forecast
Collaborating on your forecast with the team ensures buy-in, but that only lasts as long as the forecast remains accurate. And even the best laid plans can quickly go awry when outside economic conditions change.
To ensure that your forecast (and your budget) stay accurate, it’s essential that you switch from annual planning to a more agile process.
Convert your calendar year projections into a rolling 12-month forecast. Each month, replace last month’s forecast with your actuals and add a month on to the end. If your forecast has materially changed, copy the new forecast over to the budget, which is now much more flexible.
The beauty of a rolling forecast is that managers, executives and shareholders are no longer surprised when actuals don’t match what was predicted.
The challenge is that updating forecasts and budgets frequently can be extremely difficult and time-consuming using spreadsheets, which is why until recently most small businesses have skipped forecasting on a monthly basis.
Fortunately, there are now many financial planning and analysis tools available that streamline this process so any business can update their forecasts and budgets in minutes. If you’re still using trusty old Microsoft Excel for your financial forecast, it’s time to look into FP&A software.
Not only will it make your job easier, but it will significantly increase your value to the organization as budgeting and forecasting becomes core to setting and achieving goals throughout the year, not just annually.
Find what works for you
While the weight of the world is unlikely to ever leave your shoulders completely, hopefully with some direction and experimentation, you can apply these forecast best practices to tweak the model that best suits you and your company’s needs.
Blake Oliver, CPA is an entrepreneur, accountants, writer and podcast host who specializes in cloud accounting technology. He is one of Accounting Today's Top 100 Most Influential People and has been named a 40 Under 40 in the accounting profession by CPA Practice Advisor. Blake produces and cohosts the Cloud Accounting Podcast, a Top 50 Business News show on the Apple charts and the most popular podcast for accountants and bookkeepers in the world. He is the director of marketing at Jirav and lives in Scottsdale, Arizona.
