In the past many financial professionals were reluctant to conduct balance sheet forecasting. The process was tedious and time consuming – especially if relying on spreadsheets – and further compounded by the knowledge that no matter the effort the forecast would never be 100 percent accurate. The reality however is that forecasts are not about being “right” but about offering better insight into the future financial health of the organization. That level of detail is something every organization regardless of size, industry, or business model, needs in order to compete in today’s complex and competitive business world.
The budgeted income statement allows a company to forecast most of its
Forecasting the Profit & Loss (Income Statement) is simply not enough. Can you say with confidence that you’ll be able to execute on the items forecasted within the P&L? Will you have sufficient cash to purchase inventory for the projected growth or that new product line you are so eager to launch mid-year of your forecast? What about the additional workforce in your forecast; will you have the cash to support these new hires? Will you be able to finance a needed expansion? Will you have to sell additional equity in the business? Issue more debt? Sell assets? Will you have to use one, two or more of these methods and when, during the forecasted period?
None of these questions can be accurately and honestly answered without having visibility into a forecasted balance sheet. For this forecasted balance sheet to work well and be meaningful it must be tightly linked to your plan and budget in a way that every budget line affecting the forecasted income statement and all existing business rules must seamlessly affect the forecasted balance sheet.
For example, consider that 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, forecasted expenses on the P&L will require cash. This cash will have to be disbursed according to forecasted purchases and specific payment terms as dictated by suppliers. Other cash disbursements to employees, taxes, purchases of assets and other expenses shown on the 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 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 needs to be done to prepare for execution of the plan.
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.
It’s worth noting that it is downright impossible to create and maintain a budgeted balance sheet in a set of spreadsheets.
Not forecasting a complete balance sheet is a risky proposition in today’s business environment. Every organization that engages in building and maintaining a budget should have visibility into its future balance sheet. By going beyond the P&L statement and forecasting the balance sheet, financial professionals can help predict the future financial health of the company and provide the visibility needed to stay competitive and successful.
Alan Hart is a former