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Aligning your forecasts with economic trends in your sector can set realistic growth benchmarks. For instance, if the cyber security sector is growing at 20% annually, it's much easier to justify higher levels of growth.
It’s all too common we speak to business owners who don’t see a great deal of value in creating financial forecasts. We hear…
“They’re just a finger in the air job – how can you predict the future?”
“I think we have completed them before but we didn’t really get a lot of use from them.”
“We always prepare them if the bank needs them!”
Financial forecast can actually be one of the best tools for business owner if they are approached correctly. At The Advisory Group, financial forecasting is an area we are specialists in and are even relied up by financial institutions (for their clients) to prepare financial forecasts. Our specialism lies in our approach, which aims to make financial forecasting a really useful tool for business owners rather than a tick box exercise.
We have therefore shared our top tips in how to get the most out of financial forecasting:
Financial forecasts shouldn’t be standalone and should be integrated as a minimum with:
See our blog on Leading and Lagging Indicators
If the anticipated gross profit margin is 35%, this can be integrated within the targets for management and team members responsible
A detailed sales plan and related KPI’s would underpin the projected turnover for the year.
If gross profit margin is to be improved by 5%, there should be a plan to achieve this. This could be buying in bulk, becoming more efficient, etc – the devil is in the detail.
If the business experiences significant growth, has resourcing, recruitment and other overhead changes been fully factored in.
New product, service lines or other strategic changes must be integrated in the forecasts
Acquisitions – planning towards making an acquisition is critical. For example, a certain level of profit or cash reserves may be required to finance the acquisition.
If financial forecasts are not integrated with any other planning tools, they will fail to be useful.
If a business operates in a highly volatile industry or experiences significant fluctuations in demand, it’ll need to prepare financial forecasts more frequently. This allows companies to respond quickly to changing market conditions and make informed decisions.
The optimal forecast frequency may also vary depending on the stage of a company’s lifecycle. Startups and early-stage businesses may need to update their financial plans more often to closely monitor and manage their cash flow, while more established businesses will require less frequent forecasting.
Financial modelling is crucial to understand how a business you’re looking to acquire may perform inn the future. Its important to model future performance, any synergies or growth plans and the repayment of any debt (bank, institutional or to the seller via deferred consideration) to understand if the acquisition is suitable. Often modelling the aforementioned can help corroborate the consideration for the business.
Often benchmarking against economic trends in your industry is important. If for example, you operate a business in cyber security, for which the demand for services is increasing 20% year on year, growth in sales is realistic. Equally, if you operate in a sector in a technical recession, growing 5% may be a fantastic result.
Increases in wages, material prices, energy etc also need factoring in to financial forecasts.
Real Life Example:
A cyber security firm we work with has accessed data on expected wages, which showed that due to demand, it was expected the average wage for experienced consultants would raise 15% in the next 12 months. Therefore, they were able to proactively increase their prices for their services ahead of time rather than reactively once management accounts showed reducing profitability.
It’s common for businesses to compare financial performance in forecasts against their own historical or expected performance. It’s possible to access data, which compares your business against competitors/industry averages, allowing the business owners to build financial forecasts with positive external influence.
Real Life Example:
A new manufacturing client of ours was struggling with profitability/cashflow. Whilst completing some financial projections, benchmarking data showed that the business was spending more materials for each £1 of sales than 90% of their competitors. The client carried out further investigations, it was concluded that wastage was too high. By bringing material costs as a % of sales in line with competitors, the client made an additional £46k per annum in profits.
Its common for businesses to execute new growth or diversification strategies without fully modelling the impact. Financial modelling allows the business owner to conduct an in depth financial analysis on a new idea, ensuring all costs are captured, the business operationally can fulfil the new strategy and cashflow/profit remains positive.
Real Life Example 1:
A firm of consultants decided to reduce the volume of customers and instead focus on lower volume of larger contracts. As these contracts took longer to convert than smaller ones, there insufficient sales data to understand accurately what overall sales volume would look like in the year ahead. As the firm had wages and other fixed costs to pay, fully changing the business model in one year seen as too risky. Therefore, the business owners opted to complete a financial model that would execute a strategy over a 3-4 year period, gradually reducing the smaller contracts whilst a strong pipeline of larger contracts were sought.
Real Life Example 2:
A construction business took on some new, larger contracts and wanted to model two scenarios – one where they fulfil the long term contracts with employees and another with a mix of subcontractors and employees. Financial forecasts were completed showing that there was minimal difference between the profitability of each scenario (due to down time) but the model where the contracts were fulfilled by employees created periods of negative cashflow.
Often, forecasts including key areas of growth do not fully factor in the hidden cost associated. This could be one off costs, direct ongoing costs or indirect costs. For example, to grow past a certain head count may require management layers, IT infrastructure upgrades, new offices, etc.
Real Life Example:
A Food manufacturer with strategic plans to export to the US and was seeking investment. When undertaking the forecasting exercise, the one off costs associated with the move were in excess of £100k and the cashflow impact was much higher due to the time lack of credit terms as a new entrant to the US. This enabled the business owners to make an informed decision to delay the launch in the US until investment could be sought.
It’s advisable to always use a full integrated forecast model, which would include a profit and loss account, balance sheet and cash flow statement. Often a Profit and Loss is prepared but this does not factor in changes in cashflow/working capital, which are incredibly important.
Real Life Example:
A manufacturing client had an offer to renew a large contract with a large wholesaler on a better price but slightly worse credit terms (45 days from month end from 30 days from delivery). When modelled via financial projections, it was clear that profit slightly improved but cashflows were significantly impacted. The business owners still made the decision to take on the contract on the understanding a working capital plan would be created to ensure there was sufficient headroom in cashflow to trade through.
At The Advisory Group, we specialise in financial modelling/forecasting.
By integrating forecasting with overall business strategy and operational plans, business owners can anticipate challenges, plan effectively, and drive growth with confidence.
For detailed guidance on implementing these strategies in your business, Please get in touch HERE
This publication has been prepared by The Advisory Group UK Limited and is not intended to be a comprehensive statement of law or represent specific advice. No liability is accepted for the opinions it contains. All rights reserved.