Financial forecasting is an essential part of a proactive FP&A process. Budgets are valuable assets, a direct line of sight into the health of your business — as long as you take the time to look at and update your forecasts weekly or monthly. That includes your balance sheet forecasts.
Most CFOs don’t take the time to forecast their balance sheets, because it’s notoriously difficult to do so in a spreadsheet. This is a mistake because it can lead to unpleasant surprises, such as discovering the company won’t have enough cash on hand to meet payroll.
Don’t count on your P&L to do the work of your balance sheet, because it’s simply not designed to track deferred revenue or expenses. Let’s say your company has earned $1 million in revenue for a month, and has incurred $800K in expenses. Your P&L would indicate that you have $200K in cash on hand when in fact, that may not be the case at all.
Your sales team may have offered unusually long payment terms for a client, meaning you won’t realize a chunk of revenue until some point in the future. And although you’ve incurred $800K in expenses, your own payment terms may mean you don’t need to pay an invoice immediately or all at once.
What to consider when forecasting your balance sheet
If you sell products or services that prevent you from recognizing all of your revenue immediately, it’s essential that you look at your deferred revenue on a monthly basis to ensure it’s not too high. Deferred revenue is also a critical component to a company’s valuation, and is of keen interest to investors. By forecasting your balance sheet, you can identify when your deferred revenue is too high and take action to course correct, such as by restricting payment terms offered by your sales team.
Just as deferred revenue must be taken into account, so must your liabilities. The expenses you incurred during the month of June may come to $50K, but you may not be required to pay that full amount right away. Likewise, you may be required to make payments on expenses you incurred in January.
Many wonder if it’s even possible to forecast a balance sheet accurately. The answer depends on the accuracy of the income statement forecast. If you overestimate your sales in a given budget period, then your balance sheet forecast will be off as well.
One way to increase the accuracy of your balance sheet forecasts is to limit how far ahead you look. Changes can occur monthly, which will affect the accuracy.
If you rework your financial forecast right after month-end close, you can quickly and effectively analyze your actual results against the budget data. This allows you to make decisions that will impact the organization’s future performance much more quickly.
Best practices for forecasting balance sheets
Find an automated budgeting tool
It’s difficult to forecast a balance sheet using a spreadsheet, as there are too many moving parts. We recommend using a budgeting tool that allows you to forecast your entire chart of accounts and gain insight into much more useful data than just the revenue and expense forecast. An automated tool will make it easier to reforecast frequently.
Don’t forecast too far ahead
While we believe in forecasting your balance sheet, we don’t recommend forecasting too far out. It’s hard to do, especially if you don’t have an automated budgeting & forecasting tool. Each month will bring new changes that will decrease the accuracy of your forecasts.
Do sensitivity analysis
Determine the best way to book your actuals. For instance, experiment with sales and expenses within your P&L to see how they flow through to the balance sheet. This exercise will help the management team make better and more accurate decisions.
Learn more about how Centage’s flexible forecasting can make your budgeting & planning processes more resilient.