Forecasting financial statements is an important financial task. Done one to several times during a year, it allows getting a realistic picture of the yearly outcome. It shows management what revenues, costs and profits they can really expect at the end of the year.
Forecasting financial statements also brings the benefit that action can be taken to improve performance. For example, labour was budgeted to be $ 2 Mio for the current year. The actual forecast done in May indicated labour the reach $ 2.3 Mio. This insight gives management the time to initiate some correction or provide some justification.
Here come the 4 tips that will help you efficiently forecasting financial statements:
1. Apply variance analysis
Use budget vs actual (variance analysis) in order to check past performance. There are different ways of handling this. Either you have noticed during the past that there are some deviations or you find out when you actually compare actuals vs plan for the forecast. For example, if you had budgeted earlier that you will be selling 600 luxury watches within a given period of time but you end up selling 280, then it is appropriate to adjust your forecast. Make sure that you only focus on the main revenues and costs items. Get lost in details means losing valuable time and this is exactly what we try to avoid.
2. Know your business and what drives it
This bottom-up approach encourages the use of revenue and cost drivers for forecasting financial statements. Use these drivers to adjust the cost according to the predicted level of production or sales. This approach will assure that you are not going to plan every single detail but you adjust the costs based on a change of the output. For example, the output is supposed to increase from 1’000 items to 1’200 items. You are not planning all relevant costs again but you take the costs from before, divide it by the original output of 1’000 items and multiply it by the increased output of 1’200.
In the past, I even used a scale from 0 to 1 which I attributed to the main cost factors of a product to indicate its variable part. This allowed differentiating the cost changes based on my assumption of variable vs fixed costs. You can look at this driver metric approach as an advanced level of variance analysis (tip 1).
3. Make forecasting financial statements simple
The fundamental of efficiently forecasting financial statements lies in keeping things simple and clear. Apply driver metrics as described in tip 2 and perform a rough variance analysis as described in tip 1. That is all. Now, you should accept that you don’t plan all other things into detail. Administration costs, for example, you can simply leave at the previous level and not touch them at all. If you expect major changes, apply the really big ones to it but if you are not sure or only expect small changes, just leave it. Keep the article Lean Finance: 4 Awesome Tips for Busy Mgmt Accountants in mind where we talked about the Pareto rule and accepting the gap.
4. Use the right tools
You can create a good forecast if you use the right tools that will enable you to enter or make adjustments to your forecast whenever it is deemed necessary. Choose an appropriate workspace for you. For example a spreadsheet or database framework. Accounting software sometimes comes with automated features and reporting capabilities can be used since they will let you analyze historical data to help you create a forecast. Personally, I use self-designed spreadsheets to make and document my changes before uploading the figures back to the company-wide accounting software. It is all about finding the way that works best for you.
Forecasting financial statements is not only an important task but can also be time-consuming for a management accountant. The 4 tips provided aim to reduce the required time whilst still producing a good and insightful work.
Fancy sharing your experience in this area? Have a go and comment.