Business Performance & Financial Management Series #2
“Financial Forecasting – Planning for the Future”
A great discussion point among many business owners and managers centers on the concept of forecasting. Some will argue that because business and operations are ever-changing having long term forecasts is pointless and a best guess. Others are adamant that planning allows them to run more effectively and ensure that the business is on track to meet long term objectives.
There is no doubt that businesses are dynamic and ever-changing, and realistically what you envision for your business 3 and 5 years into the future most likely will not be exactly what you thought. However, by comparing financial and operational forecasts to actual results provides a critical step in allowing management to adapt resources to meet objectives. Or, perhaps it might be that management has to adjust their business objectives to meet the limits of their available resources.
Consider a typical forecast which includes sales estimates, planning for new production equipment & other capital expenditures and allows for annual labour rate increases. But what about when we consider the following:
- Annual lease rate increase; increase in employee benefits; a WCB increase; overhead costs increasing in relation to sales increases; material input cost adjustments; freight rate increases; US exchange rate fluctuations; an increase in the prime lending rate; and, let us not forget that ownership would like to have a raise too!
These and many other variables have an impact on the results of your business and directly affect your financial position. Remember too that decisions you make today will impact your operations tomorrow. Accepting a contract from a new client that will increase your sales 15% per annum onwards may require increased investment in equipment or space, while at the same time stretching your available working capital.
And, what about variances? What if sales drop 5%, cost of goods increase 3%, rent goes up 2% and overhead increases 4%? How does that affect your financial health? Financial forecasts should allow for sensitivity analysis to be performed on all key variables of the business. Imagine being able to know in advance how your working capital requirements will be affected as a result of a change in a material input cost, or by extending payment terms for a new contract out beyond your normal terms.
By utilizing sensitivity analysis in your forecasts it will allow you to recognize under what circumstances you will have financial pressure. Similarly, knowing when you will have excess financial resources may allow you to take advantage of further supplier discounts or plan more aggressively for growth and new product development.
Remember too your business objectives. By preparing and reviewing on a regular basis your forecasts with your objectives will allow for continuous improvement and help ensure that financial & operational realities are aligned with future goals.
Financial planning can be tedious and unglamorous. But by having knowledge in advance about how decisions or events will affect your business should more than make up for time spent number crunching.
Jim Melville, CA