As an outsourced CFO serving 12-15 different businesses, I’ve delved deep into the realm of budgeting and forecasting. Over time, I’ve come to believe that traditional budgeting has taken a backseat, with rolling 12-month forecasts becoming the preferred financial tool for businesses. This tool not only provides future insights but also sets a standard for the present.
Despite its potential, many of my clients don’t find the expected value in forecasting. I recently conducted an informal survey of some of my clients on their issues with forecasting and here were some of the comments:
“The 12-month forecast often seems distant since our focus is largely on the immediate future,” remarks a CEO of an e-commerce company.
“Quite frankly, our business is just not that disciplined. While we are good in the present, when it comes to the future we aren’t focused on the next 12 months,” admits a CEO of a food manufacturing company.
“The challenge lies in effective communication and execution. While I know where I want the business to go, I don’t have the management team in place that can execute on a line item level that the forecast provides,” explains the owner of a construction company.
Three Challenges in Financial Planning
From my observations and feedback, the financial planning process often stumbles due to:
- Short-term Focus: Small business owners, without extensive management teams, find it challenging to plan beyond the next 90 days. Most leadership and management tasks fall on the shoulders of a few, which makes it difficult to execute longer term strategies.
- Constant Adaptations: Small businesses frequently undergo minor changes, making it difficult for them to maintain long-term focus and discipline.
- Inconsistent Systems: Many small businesses lack systems to yield dependable results. For instance, several small businesses don’t have a system around generating reliable leads, instead using ad-hoc methods that yield inconsistent results.
The Aspirations of Small Business Owners
Small business owners often gravitate towards forecasting to:
- Understand projected cash balances.
- Strategize more effectively.
- Set benchmarks and measure current performance.
Whatever the tool is to satisfy these three expectations, they want. The problem with many forecasts is that they are number-heavy and very detailed. While most small business owners think they want in-depth financials, in my experience, what they really desire is impactful financials.
The job of an outsourced CFO is to meet the owner where they are at and build tools that will help their business. Most financial consultants and outsourced CFOs would be better off building tools to satisfy these three requirements rather than spending their time rolling forecasts. That is not to say forecasts are not good tools, or the right tool. But if outsourced CFOs would start by satisfying these three requirements, they might use different tools in some cases.
One Mission of an Outsourced CFO
A primary responsibility of an outsourced CFO is to align with the client’s requirements. While rolling forecasts are valuable, it’s essential to first address the core needs of small business owners. By doing so, different, more effective tools might emerge.
Alternatives to Forecasting
Contrary to what you might think, I’m not advocating completely discarding forecasts. However, if they aren’t meeting the small business owner’s needs, it’s time to adapt and innovate.
Steps to Effective Financial Planning
1. Understand Your Business Model
One of the most transformative yet simple tools that I use with some clients is a business model analysis. Within the tool, I put levers by the line items which the business owner can most impact. By focusing on 4-6 primary operational levers, business owners can streamline their approach and avoid becoming overwhelmed.
It’s essential to prioritize; while minor fluctuations in expense accounts might grab attention, significant changes like a 2% decrease in margin can have a more considerable impact. By simplifying financial statements to align with the business model, owners gain clarity on critical areas they can influence, enabling strategic decision-making.
2. Continuously Adapt Your Model
Business model analysis isn’t a static tool; it requires regular adjustments to reflect the current state of the business. Typically, 4-6 key levers, impacted by 10-15 primary assumptions, shape these models. As the business landscape evolves, so should these assumptions. Recognizing that some levers might become more crucial over time, it’s vital to stay attuned to potential shifts. Focusing on substantial, or “material,” issues, rather than getting lost in minutiae, can optimize business operations and problem-solving.
3. Benchmark Regularly
With a refined business model, monthly expectations become clear. Business owners can then compare actual results against these benchmarks.
There are multiple ways to analyze financial statements. Comparing actual results against your planned model is one of the more impactful ways. Once an owner sees the results, they can analyze how they want to impact change and what they need to spend time on.
4. Enhance Cash Flow Analysis
It’s a given—many forecasts and budgets don’t hit the mark. Changes in the business environment can render them obsolete in months. Most companies spend days in November and December on developing a budget with their best thoughts on what the next 12 months will entail. For between 50-60% of companies, those plans are blown up only a few months. Forecasts and budgets by their nature are only partially accurate.
Rather than viewing cash flow forecasts as definitive, treat them as trend indicators. This approach transforms cash flow projections from being crystal balls to practical stop lights. If your forecast shows issues, figure out what they are and address them. If it doesn’t, then keep moving ahead.
Simplify by focusing on core elements: revenue, variable, and fixed costs. Making projections around those three items along with knowing the other inputs in the cash conversion cycle can give you a quick way to project cash flow.
For effective revenue projections, a systematic approach is essential. If one doesn’t exist, use historical data as a baseline. With accounts payable and inventory days, we should be better at predicting them then most small businesses are. Think about it – we control these variables. We know how fast we will pay our bills and we know how much inventory we will have on hand. Its only when businesses operate “on the fly” that these variables can’t be relied upon.
Conclusion
In the dynamic world of small businesses, traditional forecasting methods might not always suffice. An outsourced CFO plays a crucial role in translating intricate financial tools into actionable insights. By focusing on core needs and embracing flexibility, forecasts and business models can be optimized, paving the way for growth and success for every small business owner.
While a complex forecasting method might seem desirable, remember that sometimes simplifying things may provide the same or better results. For small business owners, its about how to meet your goals. If a tools isn’t doing it, then its time to move on to a better one that will.
Fortunately, Krieger Analytics is here to help. We’ll use our experience to help look back at past performance and make recommendations for the future in a way that fits your vision. Contact us today to get started!