Have you ever wondered why forecasting of the corporate balance sheet is something we seldom see or hear about? Or why many finance managers and professionals dismiss it as an unnecessary activity with no real benefit to the company? The answer, according to my interpretation and understanding, is that doing a good job of forecasting a complete and accurate balance sheet is very hard, probably impossible using conventional tools (traditional CPM tools, spreadsheets or Excel, etc.).
The Early Days of Balance Sheet Forecasting
A lot has happened since the first attempts at forecasting a corporate balance sheet. In the early days of computerized planning and budgeting, the main goal was to forecast the cash flow of the company; cash leaving and entering the company in various budgeting periods (months, quarters, etc.). The focus wasn’t really on generating a “future” balance sheet with all of its components clearly presented, but more on the general accounts, such as cash, and maybe receivables, inventory, and payables.
Traditional tools made creating a three statement financial model for forecasts a cumbersome process that resulted in a potentially dubious projection rife with errors. For a small business, taking the time out to develop projected balance sheet line items with what might end up providing minimal insight wasn’t worth the time or the effort. Worse, presenting and explaining the resulting statements to stakeholders might only cause confusion.
With the available tools at the time, the cash flow forecast was usually not presented in a standard Statement of Cash Flow. Management was able to see how much cash would be required in each period and anticipated cash receipts during the budget year. The accuracy of such forecasts was always questionable, but at the time it was the only method known and used.
Those who have done cash forecasts know how hard it can be, especially if any degree of detail and accuracy is expected. The end result was often far from the actual results but it was a step in the right direction.
Can a Balance Sheet be accurately forecasted? That depends on the definition of accuracy. Under ideal circumstances, a forecasted balance sheet can only be as accurate as the income statement forecast. You grossly overestimate your sales in certain budget periods and the forecasted balance sheet, assuming it perfectly tracks the forecasted P&L, will be off too.
Nevertheless, if the forecasted Balance Sheet and its Statement of Cash Flows companion are not synchronized to the P&L and to each other, any degree of accuracy and completeness can never be achieved. This is why most of the popular planning and budgeting software solution used today are not able to provide their users with an accurately synchronized set of financial statements.
In an earlier blog entry, Take Advantage of your Planning & Budgeting Software’s GL we saw that in order to achieve a meaningful set of synchronized forecasted financial statement the software must employ a general ledger at its core and automatically make journal entries in response to budget line forecasted activities (e.g., sales and expenses in budget periods, forecasted capital asset acquisitions, etc.).
Using Modern Tools for Balance Sheet Forecasting
As noted, developing a usable balance sheet forecast from which insights can be gained requires realistic sales projections combined with the associated elements of your financial model. Therefore, it is critical for sales projections to be based on solid analysis and company data and goal if a balance sheet forecast is to get off on the right foot. Better data and clearer analysis lead to better projections.
Obviously, sales projections will influence certain elements of your forecast. Balance sheet items such as inventory, accounts receivable, and accounts payable have a constant and somewhat predictable relationship to sales numbers.
Other items may be highly predictable, or may only change with management decisions or policy changes. Items like fixed assets, long-term debt, and owner’s equity are independent of sales forecasts.
Leapfrogging older forecasts requires including more detail, and having a modern tool that is flexible enough to allow changes as you go without breaking dependent sheets or calculations. Projections should include liability items like those above, plus assumptions about short-term debts and interest expense. While cash balance may not be directly tied to sales, but influenced by it, forecasts should show reinvestment, working capital, or holdings as appropriate to the forecast’s assumptions.
While it may not be perfect, financial forecasting can help organizations to understand where to stay the path or pivot. That makes balance sheet forecasting a huge asset for small businesses who have the ability to be agile in the marketplace. With a forecast in place that comes close to actuals, small and even medium-sized businesses will have a better idea of how an opportunity or a deviation from their existing business plan might impact their financial position.
Get The Tools You Need For Balance Sheet Forecasting
Finance executives, finance managers, and finance professionals now have a set of tools to deliver a forecasted Balance Sheet and a Statement of Cash Flow that perfectly track the budget and its forecasted Income Statement. These look exactly like the actual financial statements, only represent future budget periods instead of actual accounting periods’ performance.
While I perfectly understand why they did this with the existing tools and software architecture, company CFOs and other finance executives can no longer dismiss this radically new approach to balance sheet forecasting as irrelevant or unnecessary. It’s good to see technology innovations finally reaching corporate finance management and embraced by organizations’ leadership teams.
Alan Hart, MBA, is Principal Consultant at Pacific Shine Group in Portland, Oregon, with responsibility for client business development and hands-on client project implementations. Prior to starting Pacific Shine Group, he worked in various executive accounting and finance positions with technology and growth companies. Notable is his 18 years in the hi-tech manufacturing industry where he served as Controller, Vice President of Finance and CFO of several privately as well as publicly held companies in the Hi-Tech industry, such as Hybrid Arts, Inc., Hamilton Bay Associates and Syncronys Software. In his role in management consulting, Alan has worked in diverse industries and with a variety of clients, including fortune 1000 companies such as Boeing, Delta Airlines, Intel, Wyndham Worldwide and others, as well as many mid-market organizations such as Guitar Center, Ducommun AeroStructures, Cypress Semiconductor, TriQuint Semiconductor and others.
Combining his skills and experience in engineering with deep understanding of technical accounting, he is able to assist small and medium-size manufacturing companies establish GAAP compliant accounting and reporting systems.
Centage Corporation’s Planning Maestro is a cloud-native planning & analytics platform that delivers year-round financial intelligence. With Planning Maestro, Centage offers the sophisticated features needed by small and mid-market organizations to integrate budgeting, forecasting, and deep data analysis within one easy-to-use, scalable SaaS solution. For more information on how to modernize your office of finance with intelligent planning, view our product demonstration video, or call 800-366-5111.