Every good forecast is built on solid assumptions, and it’s important to update those assumptions regularly, but nobody wants to live in their financial models 24/7 so we're often asked: how much is too much?
It really just depends on 2 things:
This one is pretty straightforward. If deal flow is unpredictable month-to-month, or you constantly adjust marketing spend on a weekly basis, then you’ll need to review and update your assumptions a lot.
On the flip side, if your business is stable and your annual forecast usually plays out exactly as you planned, then you might be able to let your assumptions sit untouched for a few months at a time.
However, never go more than a quarter without seriously unpacking whether your assumptions still hold true, and whether there is any new information to consider. If your assumptions are outdated, your forecast won't be very useful.
If you just want a general idea of where you’re headed based on the way things have been going, then you can simply identify the drivers and patterns in your historical results, consider industry and seasonal trends, and project that behavior going forward. As long as your actuals are real-time and you update your forecasts with obvious trend shifts, you’re probably good. However, that’s just table stakes (e.g. Clockwork does that all automatically) and your finances can be quite dynamic, so let’s consider a few more situations.
Maybe you’re wondering what an upcoming event or decision will do to your cash flow (e.g. new product launch, sales team expansion, fundraising). That’s a perfect time to jump into your model, update the assumptions, and really understand what’s happening to your finances going forward. Look at how your margins, cash flow, and key performance indicators will react. Make sure you’re prepared for it, and if you’re not, at least you know now, ahead of time, so you can make adjustments.
Alternatively, let’s say you have multiple options on your plate and you need to make a decision. In that case, you’re not just updating assumptions. You need to build scenarios.
What are scenarios?
Scenarios are new models - like an alternate reality - where you can explore an entirely separate set of assumptions, and then compare the outcomes against your current reality. For example, you might see a cash shortage on the horizon, and you’re not sure whether you should cut costs, get a loan, or raise a round of equity financing. You can clear it all up by building a financial model and cash flow forecast under each scenario, and comparing the outcomes to see which decision makes the most sense for your business as a whole. Once you pull the trigger and choose a scenario, those assumptions become your new forecast and you’re back to business.
Finally, it’s always good practice to build a best and worst case scenario model for your business and review it quarterly. Even if the odds are slim, it’s better to know what could happen so at least you’ve played it out. You can even build a plan for what you’d do if the worst-case scenario unfolded, or your business started growing way faster than expected, so you never have to worry about it. We live in a crazy world, but if you prepare ahead of time and stay on top of your financial models, you’ll see things coming from a mile away, and you’ll be totally in control.
Reach out to our team any time if you have questions about updating your assumptions, building out scenarios, or staying on top of your finances in general, and we’ll take care of you!