The Growing Importance of Forecasting

Few CFOs take the time to forecast their balance sheets, preferring to rely on their P&Ls to monitor their cash levels.
Chris HowardFebruary 8, 2018

On January 1, a new set of tax cuts went into effect that, among many other things, should stimulate growth in the small to mid-size business sector. I speak to a lot of CEOs who oversee companies with revenues in the $50 million to $150 million range, and they’re approaching 2018 with cautious optimism.

Chris Howard

Chris Howard

Besides the tax breaks, there’s a lot to be optimistic about: low unemployment and inflation, coupled with steady growth in the GDP and stock markets. But there’s also plenty of reasons to be cautious as well.

What happens if the new law hurts middle income families in states with high local and state taxes? Will they be able to afford their mortgages? If not, what’s the impact on the economy if many default on their mortgages?

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Many CEOs tell me they’d feel more confident if they could keep better tabs on their financials. They’ve put their plans into place based on economic and market assumptions made a few months back, but will they hold up?

My message to them is always the same: forecast quarterly, or even monthly, and then compare the forecasts to even more timely actual results. As one CEO of a manufacturing company told me, “I try to analyze actual results against my forecasts on a weekly basis, because it gives my organization 52 chances a year to make corrections.”

Forecasting is a critical endeavor in times of cautious optimism. By treating your budget as a valuable asset that you consult regularly, you give your management team the opportunity to course-correct as conditions change or new trends emerge.

To a certain extent, forecasts represent a best guess of what lies ahead. Predicting unforeseen trends and opportunities 12 or 18 months in advance is difficult in the best cases. It’s nearly impossible when the economy or a specific industry experiences uncertainty or volatility. For this reason, it’s worth considering a shift to a rolling forecast (aka rolling planning system).

A rolling financial forecast enables corporate finance teams to project out as the year progresses in order to accommodate trends that affect key business drivers. Typically, with a quarterly rolling forecast, businesses project out about four to six quarters ahead, irrespective of the calendar date or year. Of course, successful rolling forecasts depend on knowing a company’s key business drivers, so that the team can watch them for unplanned surprises.

I’ve also become an advocate for balance-sheet forecasts. Few CFOs take the time to forecast their balance sheets, preferring to rely on their P&Ls to monitor their cash levels. Granted, forecasting a balance sheet is a difficult task, and nearly impossible to do in Excel. But I’ve seen how valuable the process is, given the critical details often missed when relying on the P&L.

For instance, let’s assume a company has earned $1 million in revenue in March, and incurred $800,000 in expenses. The P&L would indicate that the company has $200,000 in cash on hand when, in fact, that may not be the case at all if the sales team has offered unusually long payment terms for a client.

That means the company won’t realize a chunk of revenue until some point in the future. And although it has incurred $800,000 in expenses, its own payment terms may mean it doesn’t need to pay an invoice immediately or all at once.

Deferred revenue and liabilities are the kinds of details that the balance sheet alone can capture, which is why forecasting it monthly is the only way a CFO will know how much cash the company will have in the months and quarters ahead.

Any company seeking growth in 2018 would be wise to include a sensitivity analysis as part of the balance sheet forecast. There are many ways to book actuals, and financial teams may want to spend some time determining the best processes for their companies.

For instance, they can experiment with sales and expenses within the P&L to see how they flow through to the balance sheet. This exercise can help the management team make better and more accurate decisions.

The largest part of a budget for many companies is workforce expenses. Salaries, hourly, overtime, employee and employer taxes, 401(k) contributions, insurance, employee stock purchases, garnishments, pre-tax items, post-tax items, and holiday, sick day, and vacation pay are just a few of the items that make it complex.

That complexity will only increase as a company grows and adds headcount. The more detail entered into the workforce expense forecast, the more accurate it will be.

Getting To the Forecast

Earlier I noted that many CFOs want to forecast regularly, but don’t do so. Coordinating data to analyze, report, and predict performance simply requires too much time and effort.

But that’s changing, and for two reasons. First, new budgeting platforms streamline the process, applying intelligence to ensure inputs are applied accurately and automatically.

Second, critical business systems, such as CRM and HR platforms, generate robust data that can be entered into the budget modeling software, enabling CFOs to create highly detailed forecasts.

When combined, these two trends enable financial teams to quickly identify where, when, and why actuals differ from plan. Armed with such data, the management team can take appropriate action.

Chris Howard is vice president of customer experience at Centage.