5-Year IMPACT Forecaster®
The 5-Year forecast is a month-by-month and summarized year-by-year projection of the P&L, balance sheet, and statement of cash flows. It should be your best representation of what will happen in the future, hopefully with as many of your assumptions validated as possible by your own historical performance. It is the necessary financial component of a comprehensive business plan, and it serves the important function in your business of being a roadmap for getting where you want to go.
This can be compiled by simply preparing and linking several worksheets in a spreadsheet program, or you can also use one of many projection or modeling software programs. Be careful about getting too committed to one software program or another. Besides having to learn how to use the software, you may also find that it won’t do what you need it to do after you’ve invested hours of time into it.
In addition to the three financial statement projections that need to be included in the model, you should have at least three supplemental worksheets to detail your assumptions. They include a main assumptions page, a marketing, sales, and cost of goods sold page, and a detailed payroll sheet.
Every 5-Year IMPACT Forecaster™ should have one page that contains all of the major of the assumptions for the model. If you are using Excel or another spreadsheet template to create the model, these assumptions should be linked throughout the model. This gives you the ability to make a change to any one of your assumptions and then see how that changes your profitability and cash flow outcomes throughout the plan.
When it comes to projecting your revenue and cost of goods sold, you need detail! It is not sufficient to say you’re going to grow sales by 50%. What are the marketing activities that will drive that growth? How many leads will you need to generate the sales required to hit that growth rate? What is the cost of these required leads and other marketing activities? Which product or service lines will grow more than others? How does your gross margin differ on these lines as compared to slower-growth or even obsolete lines? Is there a difference in both the collections from customers and your payments to vendors and suppliers for costs of goods sold for those product lines? How will this impact cash flow? These are the questions, among many others, we look to this worksheet to answer.
How many people is it really going to take to accomplish what your financial model projects? What are the salary and wage costs to hire all of these people? Are your hiring practices in line with the sales per employee ratio according to our industry benchmark? Have you correctly factored in all payroll burden and benefit costs, including FICA, FUTA, SUTA, worker’s comp, other state payroll taxes, health insurance, 401(k) match, etc.? Have you accurately forecast all of the costs associated with adding these new employees, including recruiting, HR, and new office and computer equipment? All of these questions need to be factored into your plan so that you can demonstrate a realistic cost for growing your firm.
Of all three of these supplemental worksheets and all three major financial statements – the profit & loss, balance sheet, and statement of cash flow, you need to pay particular attention to the balance sheet. The balance sheet, not the P&L, is what drives the cash flow of the business. If the balance sheet is not correctly modeled, then the cash flow forecast is most likely inaccurate and worthless. Yet the balance sheet is the part of the model that is usually the most neglected and least understood.
In order to help get the balance sheet forecasting correct, I have identified three common mistakes that entrepreneurs, CEOs, business owners, and even business financial consultants make: No balance sheet projections, failure to correlate operating activities on the P&L to changes in the operating assets and liabilities on the balance sheet, and disregard for the debt and equity transactions of the firm.
Yes, most often the biggest mistake is that the balance sheet is excluded altogether. The P&L shows profit, and many entrepreneurs think this is all they need to project. But profit never equals cash flow in the same period, so assuming the forecasted profit will be in your bank account, or the projected loss will deplete your bank account, is naïve. And, if you ever present your plan without a balance sheet to a bank or sophisticated investor, they will quickly lose confidence in you and your ability to do what you say you’re going to do. Project what will happen to each balance sheet account as each one relates to the operations, investing, and financing activities of your company during the next five years.
Another common mistake is not having the activities on the P&L of the firm accurately flow through the operating assets and liabilities on the balance sheet. The major operating assets include accounts receivable, inventory, pre-paid items, and more. The major operating liabilities include accounts payable, taxes payable, and other accrued expenses. When sales go up, accounts receivables should go up, and cash initially goes down. But does the model capture that? If sales go up, can you expect your inventory level to stay the same? Most likely it will need to increase over time. The increments of these changes are dependent upon the relationship between your days sales outstanding (DSO) and inventory turnover, which need to be included in your main assumptions worksheet previously discussed.
As sales increase, your accounts payable should increase because you are buying materials and using your suppliers and vendors more. The timing of when these costs are incurred and when they are actually paid influences your accounts payable and, ultimately, your cash flow. You need to define the relationship that payables have with your operating activities and implement this relationship in the balance sheet portion of the 5-year IMPACT Forecaster™.
There are several other operating assets and liabilities that dramatically impact cash flow that need to be tied to the growth and changes in the P&L. I’ll avoid all of the details of each, but it’s fair to say that without properly forecasting them, your projection will not be accurate and will lack the most critical information your model should include--cash flow.
Another area of the balance sheet that is often overlooked is the area that includes the loans, lines of credit, and equity transactions over the five-year period. Are you bringing in any more equity investments during the period you are modeling? What is your dividend policy for shareholders? Is some or all of the active shareholders’ compensation coming through equity? All of these items can have a significant impact on cash flow, although none of them show up on the P&L.
In addition to equity transactions, the structure of all of the company’s debts and obligations need to be correctly reflected on the balance sheet. An interest only line of credit will keep the same balance until more is withdrawn or some is paid back. Term loans need to show the correct amount of principal being reduced every month while the interest is reflected on the P&L. These types of transactions are complex, and accounting for them in the projection will help you improve the accuracy of the picture you are building for the future.
This discussion of common mistakes is certainly not comprehensive (you’ll notice I didn’t address capital expenditures and depreciation at all), but should create a positive foundation to build the balance sheet portion of the model. The underlying point is that having a 5-Year IMPACT Forecaster™ is essential, but you will likely need some help to make sure you get the most value from it. And a side-benefit of having a CFO-level person help to design, build, and then track your performance against it is that you get their perspective on how other companies in the same and different industries build and then use their projections to create clarity. They will also help you bring your assumptions and projections into line with reality, always based on historical performance and benchmarks combined with your unique business.
|5-Year IMPACT Forecaster®|
|Insightful||Empowers strategic decision-making|
|Meaningful||Decipher cash needs for growth and strategies to maximize long-term results|
|Precise||Most effective way to present to investors and bankers|
|Accessible||via SaaS technology using interactive, powerful charts and graphs so you can spend your time improving your business, not analyzing hard-to-read and even harder-to-understand reports|
|Comparitive||Industry benchmarks, assumption validation & pivots|