It is not as hard as you think and the results will greatly justify the effort
In the first part of this series we saw why we need to be able to forecast our company’s balance sheet. In this installment we will see examples of how a forecasted balance sheet is constructed and a software solution that allows its users to produce a forecasted Balance Sheet and a Statement of Cash Flows automatically from their budget data.
Here are a few examples:
Your sales on credit generate accounts receivable in the period products were shipped or services were provided. The forecasted balance sheet (A/R balances, and Retained Earning – Current) needs to reflect that, taking into account all of your credit sales to all of your customers, at the right prices and the right terms. Then forecasted cash and A/R must automatically reflect collections from these customers, according to forecasted payment terms, which may differ from customer to customer.
At the same time, your forecasted expenses on the P&L will require cash. This cash will have to be disbursed according to forecasted purchases and their specific payment terms as dictated by suppliers. Your other cash disbursements to employees, taxes, purchases of assets and other expenses shown on your forecasted P&L will also need to be considered and shown on the forecasted balance sheet (and Statement of Cash Flows).
Only then, when you have your forecasted cash receipts and cash requirements (represented by the ending cash balance in each forecasted balance sheet period, as well as the output from a forecasted Statement of Cash Flows), will you know whether or not your plan and budget are feasible and what you need to do in order to prepare for execution of the plan.
Another example is projecting in advance whether or not you will be able to meet your loan covenants Make a Covenant to Properly Plan your Company’s Financial Future or being able to forecast any financial ratio during the planning and budgeting period Why Financial Ratios Should be part of Your Budget and Forecasts. That alone is worth the effort of having a forecasted balance sheet.
The above example can be carried through to all other sections and elements of the balance sheet. As in actual accounting, every forecasted activity that appears on the budgeted income statement, must automatically find its way to the forecasted balance sheet and from there, automatically contribute to the creation of a forecasted Statement of Cash Flows.
We saw how hard it is (actually impossible to do it right) to create and maintain a budgeted balance sheet in a set of spreadsheets. Similarly, it is as hard to create and maintain a meaningful balance sheet in most dedicated planning and budgeting applications that rely on user supplied formulas, functions, links or any other user programming.
For these reasons I am a great believer and supporter of Budget Maestro from Centage Corporation which is the only planning, budgeting and analysis solution I have seen so far where the balance sheet is automatically derived from the budget and is automatically maintained; it actually evolves in real time as the budget is built. The secret to this remarkable ability lies in the unique design of the software to behave like an actual accounting system for all future periods. This concept is described here Those Debit and Credits.
Not forecasting a complete balance sheet is a dangerous and risky proposition. I seriously question the validity of the entire process when the future financial health of the company cannot be forecasted. Every organization that engages in building and maintaining a budget should have visibility into its future balance sheet. This balance sheet must be accurate and complete and above all, must automatically follow all budget input and pre-set business rules. Not being able to do that due to lack of technology tools is no longer a valid excuse why this should not be done.