SPECIALISTS IN FINANCIAL MODELLING

OK, you’ve taken the plunge – gone out on your own – told the boss to stick it and set up your own business.    You’ve left the corporate world behind and you’ll be playing by your own rules from now on!  No more management hierarchies, no boring meetings, no budgets and no getting sign-off to spend any money.  From now on, you’re your own boss and no one can tell you what to do.

The first thing you need to in order to take the amazing idea in your head and turn it into a full fledged company is to raise capital, and the first piece of advice you’ll get is to create a business plan and a forecast.    If that sounds like an awful lot of hard work – it is.  If you don’t even know where their next pay cheque is coming from, how can you be expected to have foresight years ahead on the performance of a company which exists only in thin air?   It also sounds suspiciously like a budget – something you thought you’d left behind in the corporate world.

A Budget and a Forecast are not the same thing

Let’s start out by getting one thing straight – a budget and a forecast are two completely different things.  From an entrepreneur’s perspective, forecasts are good and budgets are bad.

So why are budgets bad?  A budget by nature is static; it is very detailed, and is predominately used as a gauge for measuring actual spend and revenue in management reporting.  It focuses heavily on expenses, and most importantly, setting caps on those expenses.  They are a great tool to keep managers in check, but are they really necessary in a startup company?  No.  A suite of management reports is not a priority just yet.

At this stage in the business cycle, you don’t have much to budget.  Are you going to cap yourself, the only employee to a specific marketing budget?  What happens if you realise a few months in you need to double your print advertising and cut television ads?  I guess no bonus for you; you violated the budget after all!  So a static budget is pretty much useless at this stage.  When you get a few years into your venture, have multiple departments and managers, then hire a financial analyst to create a budget to keep everyone in check and tie their bonuses to performance.

Before you start celebrating your reprieve from budgets, let me explain that whilst you don’t need to budget for your startup, you do need to forecast.  In comparison, a forecast is much more relevant to a startup.  If built properly, a forecast will be relevant, flexible and dynamic.   It usually goes out for several years, and unlike a budget, is less detailed, and can be updated regularly to reflect the changing nature of the company.

Why we hate Forecasting

There’s no way around it I’m afraid; investors not only want a forecast, but it needs to be detailed, accurate, conservative and several other adjectives as well.  Ready to admit defeat yet?  Not having a boss is great, but in reality if you need investors you’ll always have someone you are accountable to.  Did they forget to mention that part when you were encouraged to follow your dreams and live a life of the freewheeling entrepreneur?

You’re not alone.  No normal, sane person enjoys building a full five year forecast.   Even for someone like me who lives and breathes this stuff – if there’s a choice between using Excel for “real” billable work, and sitting down to spend hours on forecast for my own business – I know what I’ll be doing.  Admittedly, Excel and Finance ARE my first loves so it’s easier for me, but most entrepreneurs are not finance oriented people.  Give them a choice between doing the BAS and clearing out the filing cabinet, the filing will win hands down.  Entrepreneurs are often creative, non-corporate types, and the mere act of opening up a spreadsheet goes against every principal they stand for.  Having to decide exactly how many employees the company will hire, what the marketing budget is, how to manage the burn rate etc. can be a very daunting prospect.

If forecasting is so disliked, why does anyone bother?  It’s your company, you can do whatever you want!  That is part of the reason you left your day to day job, the freedom of being an entrepreneur.  No one can force you to do anything anymore, and probably at the bottom of your list of tasks to take care of is building a financial model, right next to offering to do your friend’s tax returns out of the goodness of your heart.

Well, before you get too excited about the idea of not doing things just because you don’t want to, you may want to consider the purposes of the forecast.  I wouldn’t uninstall your copy of Excel just yet.

Why you need to Forecast

There are two really good reasons to have a forecast.  Firstly, any investor you approach will want to see one and if you don’t have it, the door is closed.  End of story.  Secondly, as much as you hate the idea of creating one, YOU need the forecast.  You may not want the forecast, but you do need it.  It’s like going to the dentist.  It’s for your ultimate good and health, even if it can be a slightly painful or unpleasant experience.  Imagine that freshly cleaned teeth feeling – that’s like the feeling of satisfaction you’ll get when you’ve got a proper financial forecast in place.

An interesting thing happens once you’ve gone through the painful (yet oh-so-rewarding!) process of building a forecast.  Once you get past the technical part of building the model: the formulas, naming ranges, building assumptions, designing standard financial reports (sounds fascinating right?), the fun really starts.  If you’ve built a model well, you are now in control – how easy is it to change the projected revenue from one million to one and a half million?  A few seconds and now your company just had a fifty percent boost!  Cut a few expenses (the owner always works for free anyway, right?), and your original profitability has more than doubled.  It’s a great feeling to be able to “play God” with the profits and valuation of your company.

Remember of course, that if Excel is really not your thing, and you don’t have your own in-house finance person, you can always outsource the process – if you can afford it, of course.  However, you need to own it; and nothing can replace your expertise on building the model inputs and assumptions, but it is reasonably easy to hire a consultant who can take care of the technical side of the model building.  Small business specialists will always tell you to focus on what you do best, and leave technical stuff to the specialists.

Pros and Cons of Forecasting

So… apparently you need to create a forecast to satisfy any potential investors and for your own use.  Still not convinced?  Let’s explore the pros and cons of creating this legendary forecast.

Pros

  • Promote forward thinking – a forecast will force you to think about the future and where you want the company to be
  • Help identify short-term problems – if once you are done your forecast you notice a negative cash balance starting month 3, you may have to rethink the forecast or your funding plans
  • Help get a global perspective on how to allocate resources – you now get a better sense of how bumping the marketing budget by 100% may mean cuts in other areas that you can’t now ignore
  • Create goals and targets – having it all on paper and in front of you, can help you to really plan and see what needs to happen to control expenses and ramp up revenues

 

Cons

  • Time consuming to create – especially for Excel rookies
  • Or it costs money to hire someone to create – an obvious deterrent for cash strapped startups
  • The forecasting process is a complete guessing game at the early stages
  • Entrepreneurs usually still not sold on the necessity of one, so do half heartedly – if you aren’t going to do it right, then is it really worth it?
  • You build it knowing it’s going to change three months from now anyway – reality of life unfortunately.  (You do your best at the time, and expect to revise it – in fact, it SHOULD be revised regularly)

Once you’ve got your forecasting down pat, think about taking it to the next level.  Build a rolling forecast, something that can be adjusted and modified monthly as your company performs (or underperforms) the forecast.  Sales up and salaries down?  Great!  Now force yourself to go open that Excel file once again, save a new version, and update the coming forecast based on what is actually happening.

So, what have you got planned for this afternoon?  Take a deep breath, open up Excel and get ready for hours of fun!

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As published in Australian Anthill Magazine