Make a Conscious Effort to Forecast Your Financial Position

forecasted financial statements
Why SMBs Need to Pay Closer Attention to their Forecasted Balance Sheet and Use Good Analytics.

Most small and medium size companies (SMBs) do not have the resources that larger enterprises have.  Their accounting and finance functions are often performed by the same persons and strategic and operations plans and budgets are usually done once a year, before a new fiscal year is about to begin and without too much attention to analytics.  Quite often, the planning and budget work is not done and monitored year-round.

Companies that perform well during the year, and especially those that enjoy a string of successful years with moderate to strong earnings have a tendency to fall into a state of complacency, that is, they seem to pay less attention to how their actual results compared with budgets and in many cases do little to make decisions based on actual results and their corresponding budgets. Many simply do not have the proper tools to be able to build a well-planned budget and continually monitor actual results and compare against the budget as actual accounting data becomes available.

Many SMBs still use spreadsheets in their budget preparation process, which limits their ability to properly plan and develop a budget that can be maintained throughout the year.  They also don’t have the right tools to gain much needed insight into their future financial position.

Those that happen to be on the right track and perform well may seem content with not making changes, although we see more and more such companies actively looking to change the process to a purpose designed solution, and recently to a more contemporary approach with a software solution that behaves similar to an actual accounting system, one that is able to deliver a full set of forecasted financial statements which are fully synchronized to one another and to the underlying budget.

But what happens to these companies when after several years of relative success things change and their performance starts slipping?

Unless the organization’s finance function is sophisticated and employs both experienced persons and especially sophisticated analysis tools and a good data collection system, these companies may unknowingly start drifting into an unhealthy financial position, a process that in many cases can take as long as 2 or more years.

Managements are certainly aware of unprofitability; after all, they get periodic profit and loss statements that show, on an accrual basis, that their net profit is negative.

Certain changes are usually made in order to return to profitability, but these changes, often including employee layoffs, are seldom the solution to the problem.

If the company uses a credit line or other forms of debt to finance operations, it is not uncommon to see this credit line or other debt actually finance losses. The company may be perfectly compliant with their debt obligations, and make all required loan payment.  However, in the background, their financial ratios keep deteriorating and in the case of financial loan covenants Forecast and Monitor Your Loan Covenants Compliance, there comes a time when one or more financial covenants go out of compliance, often discovered by the banker before the company has a chance to calculate it.

From my experience, one of the most important aspects of planning, budgeting and financial forecasting is the ability to forecast the Balance Sheet with reasonable accuracy, for the duration of the budget. The forecasted balance sheet must be as accurate as the budget itself and update in real time as changes are made to the budget Why You Must Forecast Your Balance Sheet Part 1 and Part 2.

Companies that have such forecasted Balance Sheets (and forecasted Statements of Cash Flows which are constructed from Income Statements and Balance Sheets) must pay close attention to how certain values change along the budget timeline. Since a Balance Sheet represents the financial position of the company (I often use the term Financial Health), using analytics tools can quickly reveal key financial ratios, financial loan covenants calculation results and other key data and how they behave and change during the budget timeline.

When you look at different versions of the budget or use several “What-If” scenarios, each of which produces a different set of forecasted financial statements, you will clearly see how the financial position of the company is affected by these various budget versions or “What-If” scenarios. This is critical to perform, so you must properly implement capable budget and analytics solutions and use them year-round.

Using analytics, coupled with a solid budget, one that produces accurate financial statements in each budget period will make all the difference between approving a budget that may not just be unattainable, but also be detrimental to the financial health of the company, versus one that is realistic, sensible, and constructed in a system that was carefully designed and implemented for the job at hand. Do this, and you will align the budget with your company’s actual capabilities.

The best news is that everything I am describing here can be achieved by even smaller companies in the SMB company space. My experience with Budget Maestro by Centage Corporation shows that even with a modest licensing and implementation cost, a smaller (or larger) organization can achieve the goals presented in this blog with a surprisingly short implementation time and with good results the first budget year it is used for.


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