If you are the visionary sort of entrepreneur, gifted and guided by flashes of intuition, the idea of applying sophisticated financial forecasting to your small business may seem burdensome, humdrum, needlessly extravagant, and just not very appealing.
Vision is good. The best entrepreneurs have it. Intuition has value and shouldn’t be ignored. But visionary entrepreneurs who disdain analysis and fly by intuition alone are more likely to crash and burn.
The “how” of financial forecasting is admittedly pretty dry, but analysis has its charms. Think of it as solving a puzzle or unpacking a mystery. And the forecasting process is less burdensome than you might think — software and a good accountant can take much of the sting out of it.
Two brief definitions are in order:
Short-range planning analyzes performance and recent trends to project the income statement month-by-month at least 12 months ahead and to generate a cash budget for the same period.
Long-range financial forecasts use sales targets to project your financial statements — income statement, balance sheet, statement of cash flows — three-to-five years ahead, usually by showing the numbers on a monthly basis for the nearest 12 months and on a quarter-to-quarter basis thereafter.
What are the value of these exercises for you as the business owner? What, in particular, does long-range financial forecasting accomplish?
Some benefits of the forecasting process have both psychological and practical value.
The exercise itself offers a change in altitude and perspective, a bit like a drone with a camera gliding over a hidden landscape. This really is helpful, because when you are stuck in the trenches, grinding out progress incrementally, day by day, your vision is limited. When you take the time to project your financials forward, you see more and you see farther.
Forecasting improves your ability to see change coming and makes it less of a brusque intruder. You are better positioned to anticipate problems and better prepared to deal with them. And when things don’t go as planned, the forecasting discipline triggers a flashing light that tells you to take corrective action.
For instance, we intuitively view sales growth as good. But growth that is too fast poses risks. Sales growth translates into asset growth. Asset growth has to be financed, either through higher levels of debt or investment.
Problems arise because risk becomes greater as debt increases relative to equity. Risk is also magnified when short-term borrowing is used to finance long-term needs.
Here is where forecasting yields its most important and most practical insights. When projections show debt increasing relative to equity or a mismatch between assets and their funding, the light flashes, telling you to tap on the brakes. Forecasting presents you with the opportunity to modify growth objectives for safety’s sake — an opportunity you might miss if you were proceeding on intuition alone.
Finally, forecasting allows you to measure success. It replaces vague goals with concrete, specific objectives. The goal line is in plain view. Success is clear and unambiguous — the numbers make it so.
Lori Haney is the Northern Nevada Market Manager for City National Bank.
