Creating a Forecast for the first time is easy if you follow these 3 simple steps!
Why create something from scratch when your previous results can be used as insights to power your assumptions? Basing your forecast on last year’s data is the perfect starting point as you are saving valuable time while making sure that the seasonality of your business is also reflected in your forecast.
Written by Hannah Dawson
Step 1: What’s changing this year compared to last year?
Identifying the core differences between the previous year and the current year is key. What has changed since last year? Did you win new contracts or clients? Did you lose an important deal? Try to break down your revenue and costs into smaller pieces and account for significant changes.
This means identifying the drivers behind the financials. If you are running an events venue then it will be the number of pre-booked events each month that drives your business. If you are operating a hotel, agreements with agents are of vital importance (The importance of Non-Financial Business Drivers).
But, don’t get lost in the fine details. You can do that later. Your focus now should be to have a view of the general direction you are heading in. Focus on your biggest revenue streams and your most significant costs. Your priority is to get a generic view first and then you can always come back and add the finer details or account for minor changes.
Step 2: Understand the difference between profitability and cash flow
By using FUTRLI, you are creating a 3-way forecast which includes your Profit & Loss, Balance Sheet and Cash Flow. It is absolutely vital that you have both a Profit and Loss and a Cash Flow, let’s explore this example to see why…
Industry Example: Agriculture
Craig recently acquired a dairy farm and provides milk to approximately 100 stores in his area. He has the same agreement with all of them. 500L of milk a month for the price of $1/L (keeping it simple so you don’t even have to use FUTRLI to do the maths for you!)
500L * $1 * 100 stores = $50,000 per month
His total costs are approximately 50% of total revenue, which gives him a monthly profit of $25,000 a month. Not bad. He is working hard but it looks like his hard work will pay off. He prepares a budget for the year, planning all of his household expenses around that as well, with the expectation of approximately $25,000 being deposited in his bank account at the end of every month. Sorted. Or is it….
Recording a profit and collecting cash, is not the same! Craig also needs to account for the timing of his cash inflows. Three months down the line, Craig has maxed out his overdraft and he is forced to try and set up a loan to keep his new business alive. What went wrong? In his original agreement with the 100 stores, he allowed 60 days of credit, however, his downfall is that most of these stores are running late on their payments so 90 days later he is still trying to collect cash.
Profitability does not equal cash
Which brings us to the next step in preparing your forecast. Accounting for the Payment Profiles and adjusting your expectations in terms of collecting your existing balances for Accounts Receivable and Account Payable. What you need to do is make sure that a payment profile is assigned to both revenue and expenses, which essentially builds your Cash Flow Statement by calculating expected Receipts (cash inflows) and expected Payments (cash outflows).
The final thing Craig would need to do is make sure that his loan repayments are taken into account, as they can have a huge impact on your cash position.
Step 3: Present your Forecast Visually
What is more powerful? Looking at a table full of numbers or looking at a chart that shows your bank balance moving upwards? Unless you are an accountant and you love numbers, I would assume it’s the latter!
Visually presenting your forecast is essential as it gives you the opportunity to identify ups and downs in your expected performance or simply to check whether your receipts exceed your payments at a glance.
After completing your forecast you can create a visual representation of your Forecast Cash Flow in less than a minute.
But don’t limit yourselves to that. Even though your cash position is important, being able to single out the costs that eat up most of your profit or being able to determine the revenue streams that give you a higher profit per dollar spent, can be extremely insightful. Creating graphical representations of your expected performance allows you to pinpoint issues, identify opportunities and focus your energy on what will pay off in the future.
The good news is that creating powerful charts has never been easier. You can either use our templates, refer to our KPI Library to get some ideas, or Build Your Own based on your business needs.
If you are still not sure how to start analysing your business’ performance today, contact us for a free consultation with our Management Accountants who can help you identify the good and the bad in your business.
To create your forecast from Last year’s actuals now please head to the link below: