Are you Still Forecasting Only your Revenue and Expenses? Part 2

Can you tell if the budget you just put together is achievable?

In part 1 of this series we saw why a forecasted Income Statement is insufficient when preparing a corporate plan and budget. In this installment we will learn how we can make this plan and budget complete and useful to management on all levels.

The real question is how to reliably and consistently forecast a Balance Sheet given all the difficulties associated with this task. By now I believe most readers of this blog realize that using a spreadsheet is the wrong approach to forecasting a Balance Sheet, see Forecasting a Balance Sheet in a Spreadsheet World. In fact, this effort will be futile, as many finance professionals have discovered. There are companies that have a rudimentary forecasted Balance Sheet done in a spreadsheet; however, all critical numbers are a rough approximation of budget period GL account balances, and should not be relied on.

Many dedicated planning and budgeting applications allow their users to construct a forecasted Balance Sheet, however, users are required to program formulas, functions and links just like in a regular spreadsheet, and the results are the same as what you would get from doing this in a spreadsheet application (e.g., Excel). It seems to me that allowing users to program their balance sheets was an afterthought by the designers of these planning and budgeting applications. The result here, however complex the model, will only show rough approximations of key account balances (e.g., Cash, A/R, A/P).

I’ve looked at many planning and budgeting software applications that claim to be a departure from spreadsheets. In many ways they are.  In other ways their functionality is just like using spreadsheets: Tedious and time consuming programming of formulas and links, troubleshooting of errors, and the inability to arrive at an accurate and complete set of future period financial statements.

There is one main reason why most planning and budgeting applications cannot deliver a complete and accurate Balance Sheet: They do not treat the budget as an extension of the actual accounting system into future periods and they cannot accomplish that due to design deficiencies. To be successful at delivering an accurate and complete Balance Sheet, the planning and budgeting solution must operate like an actual accounting system and have its own General Ledger and subsidiary ledgers (revenue, expenses, fixed assets, debt, equity, etc.).

This can only be accomplished by having the planning and budgeting software make journal entries in its own “General Ledger” in response to all budget line data that has accumulated from all business units. A more detailed explanation can be found here, Those Debits and Credits. This GL must be linked to the actual accounting GL and mirror its accounts.

With the forecasted Balance Sheet accounts updated in each budget period with debits and credits, automatically posted by the software and reflecting all activity as dictated by the budget, you consistently get a complete and accurate Balance sheet for each period defined in the budget. The Statement of Cash Flows will be just as accurate and complete since it is generated from the forecasted Balance Sheet and Income Statement.

When you work with Budget Maestro from Centage Corporation you realize why automatically obtaining forecasted Balance Sheet (and of course an Income Statement and a Statement of Cash Flows) is possible. It is the only software solution I am aware of that employs this future period automated journal entry approach to generating accurate and complete forecasted financial statements. And they do it by design and not as an afterthought.

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