3 TIPS TO IMPROVE THE RELIABILITY OF YOUR FINANCIAL FORECASTS
Most business owners probably have a pretty good idea of what their revenue and costs are in a given month, but what about some of the other numbers? What about the formulas that can give you indications of how the business might perform in the future, and the kinds of decisions you should be considering? It’s not magic; it’s financial forecasting.
Too often business owners look at past performance as an indicator of what’s going to happen next, says Greg Crabtree, CEO of Crabtree Rowe & Berger. But relying on historic financial numbers in this way is like driving down a road with a blacked-out windshield and using the rear-view mirror to go forward, he says. Forecasting helps you look at what’s coming and determine whether you have the resources to meet it.
Here’s how to improve your financial forecasts.
Keep It Simple
There are all sorts of ratios you can create to drill down into different aspects of your business, but it’s easy to get lost in the weeds with that approach if you use too many variables. Instead, start with your revenue, Crabtree says. Then look at the direct costs that did not include labor, and subtract those direct costs from your revenue. The result is your gross margin, which is a predictor of performance, Crabtree says. Also, direct labor divided by gross margin is your labor efficiency ratio.
“By creating these connections, you can make forecasting so easy,” Crabtree says. It’s easy to tinker with these numbers and see what you should be doing to keep the business growing. “You can see where you overspend, and whether you can grow into it or cut it,” he says. “That’s the way we get [businesses] to transform. You can see the next stage.”
Look at the Big Picture
Business owners often get bogged down in trying to forecast little details, Crabtree says. They focus on estimating future costs of things like office supplies when they should be looking at larger issues, such as whether the market actually wants their product or service. “The vast majority of businesses, we can get them profitable if they want to,” Crabtree says. “But for many companies it’s a decision: Are you going to be self-developed, growing out of the profits you make as a business, or are you just going to raise and then waste money?”
Using forecasting to focus on bigger questions can help you avoid this trap. Forecasting focuses your efforts on market constraints — how quickly the market wants more of your product or service, and whether you can develop the capacity to deliver that product or service quickly enough. “Too often we start telling people about what we’re going to do, before we know we can do it profitably — or even that the market wants it,” he says.
Control Your Emotions
Business owners tend to avoid doing forecasts because the numbers indicate how the engine of the business is running, and they worry about getting bad news, Crabtree says. “It’s no different than when you have a pain and probably need to see a doctor, but you wait until it’s inflamed and ugly, and it would have been better to go earlier.” But your business issues can get untenable in the meantime.
Business owners need to let go of the fear they feel about what they might learn about their companies, Crabtree says. It’s true, you may have to make hard decisions about the target market, the product or service, or personnel based on the numbers. But these decisions can help strengthen your business over the long term, so make it a priority, not something to fear.