Financial Forecasting: The Best Practices in Strategic Advising

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A business advisor helping a client understand their financial forecast

Many people assume that reporting is the most important part of being a financial advisor. However, a strong financial forecast is really the heart of any successful advising relationship. The forecast provides the roadmap, and therefore the basis for advisory services. 

Sure, reports and key performance indicators (KPIs) do provide useful information, but a rock-solid forecast provides the plan. Measuring it is how you can then help your clients make better decisions.

What is strategic financial forecasting?

A financial forecast is any component of profits, cash or equity, projected forward. A full financial forecast, sometimes called a three-way forecast, includes the profit and loss, cash flow, and balance sheet. The typical range for a financial forecast is 2 to 5 years.

A financial forecast is built using business rules, like pricing, units, volume, AR and AP terms, and budgeting information like fixed and variable expenses. Forecasts also apply assumptions, like seasonality and growth targets. And lastly, they rely on past data to ensure the projections and assumptions make sense. 

If the business wants to sell x units next month, how many units have they sold on average in the last 6 months? Do they have a basis for the new projection? This combination of things is often called a forecast model. 

Due to all of these unique elements that come together, forecasting by its very nature is a strategic activity. The level of strategy depends on the number and accuracy of business rules and assumptions that are used. It is this combination of human estimates mixed with historical data, and business rules that create a strategic financial forecast.

Financial forecasting

A financial forecast acts as a roadmap for a business to achieve its goals.  

By combining sales goals and expense needs, together with other assumptions such as cash collection days and payment timings, the business can see into their future on critical elements like profit and cash and even equity.  

Done right, a financial forecast can provide a forward-looking view two, three, even five years into the future. This kind of view is incredibly important for small business owners to make confident decisions now that will carry their business forward and reach their goals.

4 key steps to build a strategic financial forecast

As a strategic advisor, your expertise and guidance are critical. You will help your clients make sense of their historical financial information, develop more accurate projections, and apply their business rules to the forecast.

1. Understand the business owner’s goals 

The goals of the business owner are determined during the planning stage—your “getting to know the business” stage. 

During this stage, the advisor should have a broad conversation with the business owner about their goals for the business. The goals include the obvious ones, like revenue and profit, but they also include their notion of the business opportunity, the value proposition, and the sales and marketing plan to support it. Those pieces will have a direct impact on the revenue potential for the business.

2. Keep the forecast reasonable through benchmarks and history

The financial history and industry benchmarks for a business set a baseline for what it should reasonably be able to achieve. 

Using 12 to 36 months of history, the advisor should determine the business’s unique patterns for revenue, gross margin, net profit, and ratios for major expense items. Then compare those to industry-standard benchmarks for the same data. 

The objective here is to qualify the business owner’s goals with real, historical data in order to arrive at a reasonable financial projection. Seasonality is a particular trend to watch, as well as anything else that forms a pattern.

The numbers every solid financial forecast needs: 

  • Quarterly revenue targets
  • Quarterly gross margin targets
  • Expense to revenue ratios for major expense categories like sales, general and administrative, and indirect labor
  • Major fixed expenses like rent or debt servicing
  • Quarterly net profit targets
  • AR and AP average terms

With this knowledge, the advisor should have all the information they need to develop a smart and strategic financial forecast. Begin with profit and loss, and specifically the sales, or revenue numbers. Next, bring in direct costs, and then expenses (fixed first, then variable). The whole time you should be monitoring net profit. Adjust the forecasted P&L when necessary to keep the net profit on target.  

For most small businesses, a monthly forecast for 24 to 36 months is typical. Beyond 36 months, a yearly or quarterly look is perfectly fine. 

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3. Recognize that forecasts evolve over time

Once the initial forecast is built, the real fun actually begins! No forecast is complete on the initial working. The gross margin and net profit probably won’t represent the ideal, desired growth plan for the business. 

With a basic forecast in place, the advisor works with the numbers, shifting expenses, direct costs, and maybe even revenue where necessary, to model the ideal growth plan for the business. The growth plan should be one that represents the business owner’s goals, their value proposition, their sales, and marketing plan, and can support a positive or neutral cash flow.

Depending on the business, it could take 3 to 6 months of shifting, and comparing forecast to month-end accounting data, to arrive at a solid plan. And even then, by design, the financial forecast should evolve as the business grows and changes. 

4. Use the forecast to grow the business

The end result is a true roadmap for the business. Management decisions should tumble out of the forecast as tasks ready to act upon. 

Is it time to place the inventory order for the new revenue stream? Time to hire a new salesperson? Time to purchase that new piece of equipment? The financial forecast will tell you. All the answers are there. It’s not a report about past performance or a static baseline budget. It’s a plan and should be used as such. 

12 tactics for better strategic forecasting

Think about this process like solving a mystery. And who doesn’t love a good mystery? You have facts, clues, and evidence in the building blocks you’ve established by understanding your client’s goals and doing the benchmark research. 

It’s actually a fun process to methodically work through the pile of information. One bit at a time, asking the next logical question of the data set (and your client), until you have arrived at the best possible scenario: a financial forecast for this business. Not just any business, but this business. Here are some tactics to consider when forecasting.

1. Remember, forecasting isn’t budgeting 

Forecasting and budgeting are two different things

Budgeting is about setting limits on spending, usually at a granular level. Budgets are also for a shorter time span, typically yearly or half-yearly, and are not meant to be updated based on what is actually occurring in real-time. 

Financial forecasts are meant to be strategic, so they cover broad categories. Forecasts are meant to be updated regularly based on new information about the business.  Because forecasts project over 3 – 5 years, the regular updating keeps the projected profit and cash more accurate.

This is what makes forecasting uniquely different from budgeting. Budgeting is usually very conservative, and it’s much more granular. Forecasting is about potential. What’s possible? How can we get there?

2. Forecasts are rooted in smart assumptions

Always remember, at its core, a forecast is about assumptions. It’s not accounting, and it’s not budgeting in the traditional sense. Forecasting is making educated guesses about what is reasonably possible and using business rules and the financial model in the software to turn the guesses into projections. 

Using a forecasting software tool that prompts for and holds the assumptions, makes forecasting easier and more accurate.

3. Start with a solid structure

To create a great forecast, you have to start with the building blocks—the structure.

The structure of a forecast is comprised of the basic financial components: revenue, direct costs, expenses (fixed and variable), AR and AP timing, debt servicing, and other assets and liabilities. The components of the profit and loss statement are usually completed first, and then if possible cash flow and balance sheet. Utilizing a cloud-based software application to sync with your accounting data and assist you with the forecasting calculations will make your job easier. 

4. Understand your client’s goals and their limitations

In order to properly forecast those primary components, an advisor must understand the goals of the business owner, as well as what is reasonable for the business, based on its own history and even limitations.  

Limitations are just as important as goals. Can the business owner only work certain hours per week, or only exist in a certain location? And remember that goals for small business owners can often extend beyond profitability and be a mix of personal and business. Are they trying to build personal wealth or a college fund? Or pass the business on to another generation?

In addition to goals and limitations, you’ll want to consider market trends and benchmarks: financial metrics for similar businesses in a specific industry. If you can find software with easy access to normalized industry-standard benchmarks it will save you a lot of time. It’s also great to be able to come back to the benchmarks each month when you check in with your clients to see how their progress is doing against the running benchmarks. 

6. Communicate with the business owner

Here’s an important rule to remember: The business owner owns the sales forecast (often called the “top line”), and the advisor owns the expenses. 

As much as possible, let the business owner predict and own their sales (revenue) goals, and then you help to ensure the expense side is realistic, using all the historical accounting data and benchmarks as a basis. 

It’s their forecast, after all—it should reflect their goals. If their goals don’t pencil out, you’ll need to work with them on a version that does, but you have to flesh out their goals with them.

7. Always have a baseline 

Know what they have the ability to do based on historical performance. Know what others in their industry do. Know industry standards like gross margins, burden rates, and ratios for major expense categories to revenue. 

For instance, what is the ideal rate for SG&A expenses as a percentage of revenue in their industry? A good forecast is always grounded in reality.

8. Don’t forget about hidden costs associated with the growth

This is where your expertise from your profession and your intimate knowledge of their books really come in. Use that expertise to be sure everything is thought through. 

If the client decides to take on a new revenue stream, be sure you help them think through all the new types of costs associated with it and anything that might be unique for their business. Also, be sure you think about their resources and partners—who and what they rely on to run their business. Those add huge depth to a good strategic plan, adding revenue or saving expenses if leveraged correctly.

9. Explore what-if scenarios

Once your original forecast is working well as a roadmap and helping your clients to make confident decisions, you’ll want to consider what-if scenarios. These are new forecasts where you explore business opportunities, like new revenue streams, increased staffing, the purchasing of capital equipment, or even new locations.  

Remember to include what-if scenarios as a value add to your clients in your service package – it’s a big benefit to them. Also, find software that allows you to create what-if scenarios without changing your original working forecast.  

10. Use forecasting tools

As you can see, there are many elements to building a strategic financial forecast. Employing a software tool that includes these components will not only save you time but ensure that your forecast is more accurate and accessible for your clients. And when evaluating tools you also want to consider software that will help you scale. 

Complicated software that allows you to customize everything about a forecast seems tempting because you have options. However, it’s actually those options that will get in the way of your ability to scale. You want to choose software that will keep things streamlined and standardized, keep your work simple, while still producing a useful working forecast and performance review.  

These are the features to consider when you evaluate software tools for forecasting:

  • Integrated planning and strategy
  • Incorporates business model assumptions with standardized revenue and expenses
  • The ability for multiple forecasts and what-if scenarios
  • Directly build complete profit and loss, cash flow and balance sheet
  • Access to industry-standard benchmarks
  • Connection to accounting solution to help start forecasts and monitor progress

11. Know when it’s time to update, and when you shouldn’t

This is a crucial skill developed over time with your clients. Know when it’s time to make an adjustment to the forecast, versus providing feedback and working with your client to change their business process. 

For instance, if a revenue goal isn’t being met, be sure to work through all the reasons why before deciding it is unrealistic. If gross margins are off, dig into why. That’s where the advising part comes in. It’s perfectly fine to change forecast projections. Just don’t forget that the conversation about why projections are not being met (or are being beat) should happen before the change is made.  

Your advising feedback is not simply about showing numbers. It’s about getting the business owner to make changes to their business that will keep them aligned to their roadmap, and achieving their goals.

12. Be mindful of price and value to your client

Be sure you’re setting up your advising packages to take into account the value of forecasting to your clients. Your practice can be enormously profitable with this work, but you have to charge for it and be sure your clients understand the value it will bring them.

Establish your foundation with strategic forecasting

You should consider forecasting as a service to your clients. It’s strategic and fun—one part creative and one part structure. Working within a framework of the client’s business model, and adding your own financial instinct and know-how, your drive can help a business owner understand the new potential in their business and push them beyond where they thought they could go! This work is truly rewarding like no other.

If you are experienced in financial forecasting and looking for tools and resources to take your advising further, check out LivePlan, the LivePlan Method for Strategic Advising, and Growth Planning.

If you are new to forecasting and want to learn how, check out our regular webinar series and video resource library.

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Elon Glucklich
Elon Glucklich
Elon is a marketing specialist at Palo Alto Software, working with consultants, accountants, business instructors and others who use LivePlan at scale.
Posted in Advisors & Educators