By: Alex Wunderlich
“Can we hire more staff?”
“How will this new deal affect our cash flow?”
“Should we take on funding?”
If you want to answer questions like these, you need a reliable financial model to explore the numbers. There is some real-world experience and domain expertise involved, but at the end of the day, you can’t make a major business decision without understanding the financial impact.
The problem is that forecasting has historically been more art than science. Sure, most models are built on sound accounting logic, and at least some hard data, but they’re generally driven by a number of assumptions that are really just someone’s best guess.
“We had a 40% gross margin last month, so that’s our assumption going forward.”
“The Sales Manager thinks we’ll grow 10% next quarter.”
“I can feel it - this is our year.”
While forecasting will always involve a bit of guesswork, most businesses cut way too many corners. They fail to account for nuances affecting their business, and they guess in situations where there’s plenty of data to back up a more detailed assumption.
If you want an accurate forecast, you’ve got to minimize the guesswork wherever you can. Here are 3 ways to do that:
1) Pick the Low-Hanging Fruit
First things first, make sure your model has the most up-to-date actuals. There’s no use in looking for trends in outdated information, or setting fancy growth assumptions based on inaccurate starting points. You know what they say - garbage in, garbage out. An accurate model begins with clean, real-time actuals.
The other piece of this is making sure you’re updating your assumptions as things change in your business. If you’re still using last year’s growth assumptions, but you’re selling entirely new product lines this year, obviously your forecast isn’t going to be very accurate.
Long story short - update your model. It might sound simple, but this stuff is overlooked way too often.
2) Use the Information You Already Have
I’m willing to bet you have information about your business that isn’t accounted for in your forecast. Maybe you’ve added things like seasonality in your revenue forecast, and you’ve broken out fixed and variable expenses in your model, but that’s the bare minimum. Your business is probably quite a bit more complicated than that.
If you really want to dial in your forecast, open up your CRM and look at your sales pipeline, conversion rates, customer behavior, etc.. Or hop into your accounting system to analyze your expenses, and see how variable costs differ across activities and departments. For cash flow, check out your invoicing, credit card, and bill payment data to get a better understanding of how revenue and expenses become cash flows, and the timing of it all.
I could write a book about this part of forecasting alone, but the bottom line is that setting flat growth rates or copy/pasting last year’s results is a lazy way to model your revenues and expenses, and it’s probably wrong.
You have tons of information at your fingertips which can significantly increase the accuracy of your forecast. Know where to find it, and incorporate it into your modeling assumptions so your “best guess” is truly as good as it can be.
3) Know What You Don’t Know
Now that your model has the most up-to-date information, and you’ve added an extra level of granularity to your assumptions, you’ve got a pretty good picture of where your business is heading and when cash will be coming and going. However, there’s still a lot that you can’t predict.
What if the market grows faster than you expected? What if that big deal doesn’t actually close? What if you need to hire more staff than you originally thought? The “what-ifs” can make you doubt even the best financial model, which is why it’s important to incorporate at least a couple of reasonable scenarios into your forecast. This essentially means building an identical financial model, but changing a few assumptions and seeing how growth, margins, and cash flow compare to your main forecast.
You can model any number of scenarios, but a minimum, you should at least have “upside” and “downside” scenarios, where you model the best and worst case outcomes (within reason) to see what would happen to your finances. When you understand what you can’t control, but you’ve modeled the possible outcomes, you can be prepared for whatever comes your way and sleep a lot better at night.
By learning how to incorporate more data and logic into your financial model, you’ll be able to approach forecasting more scientifically, and rely less on gut feel. You have plenty of information at your fingertips, so use it to your advantage. You’ll never completely eliminate the guesswork, but when you accurately model the known factors, and identify your model’s weak points, you’ll not only gain a better understanding of your business, but you’ll also make decisions with a lot more confidence.
There's a lot to keep track of, and that's exactly why Clockwork exists - because your forecast should be detailed, but it shouldn't be difficult. Clockwork’s AI learns from your accounting data (down to the transaction level) to automatically build custom financial projections and cash flow forecasts in real-time, with advanced assumptions and unlimited scenarios to play out all your "what-if" questions.
Reach out any time to learn how we can help!