Dealing with uncertainty is, more than ever, a daily challenge for many businesses and charities. So how can a business owner, trustee or FD create a financial plan which takes that uncertainty into account; to create realistic budgets and targets for an organisation while being comfortable that adequate funds will be available? We’ve helped a number of clients with their financial budgets recently and here are some of the common themes.
- Be clear on the purpose of forecasting – the aim is not to accurately predict the future, the aim is to identify the range of possibilities and then to understand the impact on the organisation’s financial resources. If your sales team has a target to increase sales by 20% but sales have been flat in recent years, then perhaps your budget needs to include a second scenario which shows the impact on the business of sales staying at the current level. Including such a scenario shouldn’t detract from the main target, but it will enable management to understand the impact of flat sales on the business’s resources.
- Is a fully integrated model required? – cash remains king, and the number of businesses which can assume net profit is a suitable proxy for cash generation is small. We usually recommend including forecast cash flows and projected balance sheets within the budget model. This is particularly important where trade is seasonal, significant capital expenditure is expected, or when a business has a large working capital requirement – all these factors create large differences between monthly profits and monthly cash generation.
- Static or moving model? – a static model – i.e. a forecast created at the start of the financial year which isn’t revised or flexed at all throughout the year – may be adequate where a business is relatively stable and the range of possible outcomes fairly narrow. But where results are more volatile it is worth creating a more detailed model which can be updated from one period to the next (whether weekly ,monthly or quarterly) so that your forecast remains relevant. A moving model is more complex but will give management more confidence that their plans remain viable.
- Remember lending requirements – if a business is required to comply with financial covenants, perhaps as a result of an agreement with a lender, then you should include the relevant indicators in your forecasts so that you can assess the headroom against each of the various covenants. Also, if you have entered into a facility agreement for a longer term – e.g. a three or five year term loan – then it will be worth extending your forecasts over the term of the facility to check you will remain compliant with the lender’s requirements.
- Challenge the key assumptions – this brings us back to the purpose. None of us has a crystal ball, but we need to be reasonably sure that actual results will fall within the forecast range. In a larger organisation, this will only be the case if the preparer of the forecast is challenging the information he or she is given (e.g. sales pipeline conversion rate, manufacturing lead times, suitability and timing of new joiners etc.).
When management has a robust set of forecasts in place, and when actual results begin to consistently fall within the range of outcomes set out in those forecasts, then a business can begin to plan with more confidence, knowing that it is positioned as well as it can be to deal with an uncertain business environment.