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 Forecasting
How do I make a forecast without data? May 2011 "I've always been pretty accurate when I forecast sales for my company's products. But now the R&D team has come up with some brand-new technology (very cool, by the way) and the board wants me to prepare a sales forecast that will help them decide about long-term funding. We have no sales history, no pricing, no cost analysis, no customer feedback, no competitive benchmarks... well, you get the picture. Help!" Mike: This is exactly the problem that faces every startup, and I'm sure the board realizes that they're asking for a lot. But their only other option is to give you a blank check based only on "coolness." That's not going to happen. A good place to start is by creating separate cost and revenue forecasts. Work with your development team to get realistic numbers (including capital costs) for turning their new technology into a finished product. Include credible budgets for marketing, distribution, post-sale support, and overhead. Then look at the new product's revenue potential. Interview current customers to get their reaction, look at the competition, figure out reasonable pricing and sales models, and test key marketing messages with small groups of prospects. Leave plenty of time to tweak the plan--once you've locked in your pricing and marketing, it can be very expensive to make mid-course changes during a full product launch. These two forecasts will go a long way toward eliminating unknown factors, leaving only one big question mark--how many units will you sell? You can give the board an educated guess, but in the end that's the one number where they'll have to rely on their own gut feelings. Should my forcast include a balance sheet? May 2010 "I'm trying to develop a forecast that will show best-case and worst-case outcomes, and I'm stuck on how to define 'worst case.' There always seems to be something 'worse' than what I project, even though the likelihood gets silly (e.g., what happens if a meteor blows up the planet?). Is there some standard way of deciding when a worst-case risk is meaningful?" Mike: Measuring risk is a very, very difficult task, as you've discovered. In fact, many of the risks that can kill a business--for instance, the death of a charismatic CEO or a fire that destroys all your inventory and records--are sometimes called "earthquake scenarios," because they happen more or less at random. At most, you can buy insurance to protect against the financial impact of these risks. But you can't plug them into a financial forecast. However, you can make worst-case estimates for more common risks that affect your ongoing revenues and operations. For instance, what would happen if you lost your single biggest customer , a critical supplier, or your patent rights to an essential technology? For bigger, diversified companies, these worst-case scenarios might cause a short-term dip in sales of maybe 10% or so. But for a newer company with one product and just a handful of big-ticket customers, the result could be a meltdown so severe that you'd never recover. Should my forcast include a balance sheet? May 2010 "My CEO wants me to present a budget and sales forecast to the board, with a 'simple' cash flow analysis. I think the forecast should also include a balance sheet, but he insists that will just confuse most of the board members. Who's right?" Mike: It's very possible that some of your board members are clueless about balance sheets. But without a balance sheet, the board can't get an accurate picture of the financial position of the business. You'll just have to educate your board members--and perhaps your CEO--about what the numbers show. In fact, I'd argue that the balance sheet is the single most important document in a standard financial presentation. (The others are the income statement, the cash flow statement, and an analysis of the equity accounts.) The balance sheet summarizes your current financial position, and it ties together those items not on the income statement that affect your near-term cash balances, such as your receivables, payables and current notes due. And it's the basis for cash forecasts and credit-based lending decisions, including bank debt What issues should a forecasting model cover November 2009 "I asked a management consultant to develop a forecasting model for our business, but what he gave us is little more than a toy. I know it's my fault for not giving him better instructions. What should I have told him in the original requirements spec?" Mike: Well, there's no industry standard forecasting format.
But I've seen literally hundreds of models and designed a few hundred myself,
so I'd say the key elements include the following: An opening page that clearly highlights operating results and cash balances, along with projections for revenues, collections, expenses, payments, and upcoming financing requirements. I find it's helpful to summarize all of these numbers with easy-to-understand graphs and charts. Behind the scenes, the model must be fully integrated. On the balance sheet, cash and retained earnings must agree with the cash flow and income statements, and assets should equal liabilities plus equity. There should be income statements for each business unit, with department-level summaries of major expense categories (such as compensation, travel, and facilities). You should also have a page that includes a headcount summary (where you calculate salary expenses) and identifies assumptions about revenues, collections, equipment purchases, depreciation rates, accounts payable terms, deferred revenues, and debt and equity financing. Be sure you try out the model on the people who will use it--your directors and top-level managers. If there's something they find confusing, fix it. Remember, your job is to organize the model so a sophisticated reader can grasp the essentials without a lot of hard work.
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