Tuesday, June 24, 2008

How & Why to Create Financial Forecasts

Focus brings results.  Get a handle on your results year-to-date, then forecast them going forward. Make choices about where to spend your time and money. The aim is to get what you want. Intentionally.

Start with a month by month spreadsheet, using the picture you already created for the first 6 months of the year. (OK, or 5 months, with a June forecast that you're fairly certain of) This blog isn't the place to specify line items, so use your judgement; what's the highest level of detail that will be useful in making decisions? You can always add detail later, start at the level you find meaningful.

Do keep fixed expenses separate from expenses that will vary meaningfully at different levels of activity. (In other words, if you're going to buy a building, forecast the expense increase on a separate line. If you're going to add more staff, be sure salary expense is on its own line, but don't include a line item for increased toilet paper expense.)

Quick and dirty forecasting: (all right, quick might be an overstatement)
  1. Annualize what makes sense (office expenses, salary expense, anything that is predictable at the approximately the same monthly rate)  Note- if you there were unusual/one-time revenue or expense items in the first half of the year, be sure you pull them out before you annualize.
  2. Incorporate assumptions that have a high level of predictability, such as a certain level of revenue you are attracting consistently, retainers you've nearly signed, salary expense related to adding an assistant in September, rent when you move out of your home to an office, etc. DO write them down, and DO add them on their own lines in the appropriate month so they are easy to add/change/delete.
  3. Apply percentage increases if it makes sense, using YTD results and emerging trends. Again, document assumptions and incorporate them in a way that it's easy to change them and see the impact.
  4. Make some wild-ass high/low assumptions. These are usually going to relate to revenue & capacity. If you think your first half marketing will pay off, do you want to throw in 40% more revenue over 3rd quarter? If so, do you need to add a staff member? Computers? Office space?
  5. Create "bottom-line" scenarios using your high/low assumptions
Unless you're reporting to shareholders and analysts, the value of forecasting is in the process, not the accuracy. If actual results vary wildly from forecast, you'll see why and change what you're doing in time to change the results. (or you might change your assumptions and see what's more likely to happen)

The standard is "directionally correct". Your billing system and other software should provide data and reports. If it's an option, have your accountant create a forecast for you on a monthly basis. Don't over-analyze. Do your best. The other thing about forecasting is that the more you do it, the better it gets. (& easier, because eventually you'll figure out how to automate or delegate it)

Bottom line- you're the CEO, you're responsible for results. Having this information and blocking the time to strategize and change your resource allocation isn't optional.