Last blog I wrote about comparing your business’ actual performance to your budget – called variance analysis. Once you have this information you should ask your self – so what? What does this tell me about my business?
The answer to “so what” should be your forecast. Your forecasts represent predictions of future performance (and achievement of budget targets) based on current information. You might ask – why do forecasts if you’ve done a budget – what’s the difference?
Here’s a non-business example to illustrate. Suppose you plan a 4-day road trip from New York to Los Angeles, you plan to make the following stops: Chicago, IL; Lincoln, NE; Grand Junction, CO; Los Angeles, CA. To be safe you won’t drive more than 12 hours per day. To relate this example to financial monitoring, the overall objective is to make it to Los Angeles in 4 days, and reaching each destination within a 12 hour driving day represents individual budgets.
Assume on the first day your car gets a flat tire outside of Cleveland and have to spend the night there. To relate this to financial monitoring, your variance analysis would show that after 12 hours of driving you expected to be in Chicago, but you are in Cleveland.
If you continue your 12 hour driving days from Cleveland, your forecast could be represented by a new stop plan: Cleveland, OH; Omaha, NE; Moab, UT; Los Angeles, CA. Or if, you the overnight stop in Chicago was mandatory, then you may have to postpone your eventual arrival in Los Angeles by one day with a new stop plan: Cleveland, OH; Chicago, IL; Wichita, KS; Albuquerque, NM; Los Angeles, CA. This represents a different forecast.
Your ability to forecast will allow you to make a decision (whether or not to stop in Chicago) and take an action (let your counterpart in Los Angeles know your new plan) on your trip.
For your business, the forecast does the same thing. It is the “so what” answer to your variance analysis – it tells you the impact of continuing your current performance will have on achieving your target, and allows you to make new plans to achieve or exceed your targets. Businesses that are forecasting to be behind budget targets can make changes to achieve the annual budgets, and those that are forecasting to be ahead of budget targets can decide to increase the budget targets or invest for the future.
Your business forecasts should be based on the same drivers as your budget and variance analysis and should be done on all of the key elements of your business (demand or sales, costs, capital investments, cash flow, etc.).
To pull financial information together and use it to drive your business
– Once you’ve completed your variance analysis, ask “so what?”
– To answer this question, create forecasts of key elements of your business, based on current information
– Use forecasts to develop new action plans to achieve or exceed your business targets
Copyright 2013 Ryan Luke. All rights reserved.