I have found in my career that one of the most common tools that are not in place for business owners is income statement, balance sheet and cash flow forecasting. The role of the Chief Financial Officer in companies includes the duty of forecasting but in companies that don’t have an in-house CFO these duties are often neglected. Smaller middle market companies with less than $100M in revenue often don’t have the need for a full time, in the chair CFO and can function pretty well with a strong controller.
One of my clients has a legacy of over 100 years in business but had never had an internal CFO when I met them six years ago. They have a top notch controller who is able to manage all aspects of the internal reporting, compliance filings and staff management. Her strength was not in the area of forecasting, although she is very capable. When the company hit a rough patch due to the drop in the economy, they found themselves out of covenant with the bank loans and the bankers were requesting annual forecasts. This was to see how the company was planning to turn this around and get back into grace with respect to the loan covenants.
It so happened that a mutual connection put me in touch with the CEO who had asked the controller for help with the forecasts. When she stated this was not her area of expertise, he knew he needed help. For the past 6 years I have been helping them with their forecasting needs which not only meet the bank’s needs, but fill a vital role in turning the forecasts into working budgets for the company on an annual basis.
When you need to factor in capital equipment budgets, repayment of loans, shifts in balance sheet accounts and payment of taxes and dividends to shareholders the forecast involves much more than just a sales and profit estimate.
Today there are stronger tools to assist in the forecasting work that factor in these variables. Excel is a great tool for spreadsheet modeling but takes a distance second place when you are attempting to forecast not just an income statement but the balance sheet and cash flow statement as well.
It requires a strategic CFO with understanding of not just the income statement factors but all other factors including AR collection terms and history, scheduled loan payments and maturities that impact the use of cash flow from profits or other sources.
No forecast is ever 100% accurate nor is a budget ever met, but by having stronger assessment of the factors that can impact the forecast the forecast can and will be more accurate.
Trend line analysis as well as historical norms are helpful to assess the likely hood of collecting your accounts receivable or your cost of goods sold being within a small range. The better a company can enhance their forecasting the more likely they will see the need for a larger line of credit, equity or additional debt long before it is needed.
Short term forecast should serve to warn you of cash flow deficiencies or crises regardless of your profitability. Some other factors can outstrip the company of the working capital earned via operations.
Long term forecast can help demonstrate the working capital needs as companies embark on growth or expansion plans.
Don’t forsake creating the forecast to include your integrated income statement, balance sheet and cash flow statement. Everyone from the investors, bankers, buyers and those in leadership of the company all demand to know where the company is headed. The forecast will allow the warning signs to be evident from the forecast rather than running the ship aground and then calling for a tug boat.
One of the key duties for a Chief Financial Officer or strategic CFO advisor is to provide business leaders with proven insights into what the future holds. Of course this is not done with a crystal ball, but with well-designed forecasting tools. The acronym CFO also requires them to be the Chief Forecasting Officer!
I have never regretted telling a CEO/President that the future ahead if filled with some concerning financial issues, when I can show them in black and white the factors that are leading to those conclusions. A strong forecasting tools is akin to GPS for a driver navigating in a new city, essential!
If you are a business owner, CEO or shareholder in a company and do not have a Chief Forecasting Officer, contact myself or one of my partners to discuss how we can help you!