FD intelligence

How confident are you about your financial forecasts?

Rob Bayliss Rob Bayliss

Confidence in financial forecasts can be misplaced, particularly when success depends on them. As a CFO, it’s right to be concerned by numbers that aren’t assembled in a clear and logical way.

Imagine it’s the night before the big deadline – that major bid submission, or exchange on that big deal. You and your team have burned the midnight oil and everything is in shape.

Or is it? Here are six things to look out for:

1 No ability to stress test

This is forecasting at its most basic. You need an easy way to see the impact of key risks and a box where you can change volumes, prices and margins or turn off a key contract, and then see what happens to your cash.

2 Trends that carry on forever

It’s easy to base a set of forecasts on excellent continuing trends. The maths is easy and the story is clear.

Actually that’s lazy forecasting. Has sufficient thought been put into what might change, and more importantly how the business would respond? Are you still sure of that mountain of cash in year five?

3 Forecasting under-investment

Growth is likely to cost you. Imagine a sandwich chain showing a doubling of sales but nothing spent on fitting out new shops. Most of us would wonder how that growth could be supported. Likewise for the manufacturer showing volumes rising with each new contract, but no new headcount or plant.

In a set of forecasts we might want a few key ratios that speak to asset intensity and spending. If these get out of control, we need to know if there’s a reasonable explanation. Or have the commercial realities been forgotten and spending trimmed to show enough cash free to repay the debt?

4 Working capital

Here’s where it gets tricky. Your forecast shows growing revenues, but how soon does that come through to cash? Common approaches hold receivables flat, or link it to last month’s sales – the cash in is just the balancing number. Same for payables. But what if you get seasonal peaks? And what about uneven items like advance supplier payments, rent, and VAT?

Most businesses have a few areas where profit and cash don’t follow the same pattern. If you haven’t modelled this, you could be very exposed in those months when things get tight. This is an area where you need more stress testing.

5 Excel spaghetti

Forecasts, and the models that make them, should read from top to bottom and left to right like a book. Start with clear and organised assumptions, and follow them through to the results. The numbers tell their own story.

If you dig, and get entangled, then this isn’t happening. This number links to that number which goes back to the front; if you can’t follow the flow, how do you know it works?

6 Mind-blowing long formulas

The margin calculation that the whole forecast hangs on is something you need to get your head around.

But the lines that do it have formulas longer than your arm, and include functions you’ve never heard of. Still feeling confident?

Complex formulas will always be a big risk area in forecast models. If you see complex formulas and don’t understand them, don’t castigate yourself for your lack of Excel expertise. Long formulas indicate that the person who created them has lost track of sound modelling and forecasting principles.

Prepare yourself for forecasting

The good news is that the points above are really just forecasting common sense. Getting enough sound commercial and strategic input as you go, and having tools that capture the business dynamics in just enough detail, will help you hit that big deadline and thrive in what comes after. And if you and your team don’t quite have the skills, or more likely the bandwidth, to do all that, help is available.

To discuss financial forecasting in more detail, please contact Rob Bayliss or Mark Robson