When small business owners are stressed from financial uncertainty they need information from their accountant that will help them from feeling blind-sided by unknowns, and enable them to forge a clear path forward.
Most business owners don’t expect their accountant to make the big decisions for them, but they do want help understanding their numbers. They want analytics and information so they can make the big decisions with more confidence. That’s where public accountants like you can really help.
During a major business disruption, it is imperative that the owner can see ahead for the long term, to make strategic decisions and decide what action to take (hire, fire, create a new product, establish a line of credit, etc.) Further, they must be able to reassess decisions continuously as things unfold.
Complacency in a crisis is the biggest threat to small businesses. When times get tough, each day a business owner doesn’t act could mean serious financial implications.
Financial scenarios show a full financial picture of a business’s future under best-case, worst case and in-between conditions, to help a small business owner make the best decisions now. They act as a roadmap for the business.
This type of work is perfect for a strategic advising practice. But even if you don’t offer these services now, you can get started with financial forecasting as a service for clients, especially during uncertain times.
Financial forecasting and budgeting
Creating (also sometimes called modeling) financial forecasts, is similar to budgeting, with some important differences that make forecasts more useful for business planning and management.
Financial forecasts paint an entire financial picture of a business by addressing all three financial statements: profit and loss, cash flow, and balance sheet. Small business owners must be able to see and understand forecasts of profit and cash, (and even liabilities, assets and equity), with the added ability to model loans, investments and lines of credit.
Financial forecasts are longer than 12 months, typically 24 - 36 months depending on the business’s size and history. The business has to be sustainable and viable in the long term, no matter what the new economic conditions are.
Forecasts are not by chart of account line item, they are more summary, or strategic in nature.
Best practice is to develop both: a financial forecast and then an annual budget. The forecast provides the roadmap and plan, and the budget sets limits to match, keeping the business in line with its forecast.
Three types of financial scenarios
It’s tempting to think you can build a forecast using historical information and automatically extrapolate a future cash position.This method of forecasting can be useful for a stable business environment and a short term look at cash (usually no more than 3 months) but is highly misleading in dynamic environments, and can be devastatingly wrong in a crisis situation.
For similar reasons, you also have to go beyond tax and compliance advice. Applying and leveraging regulations are certainly important, but that alone won’t cover the full scope of business decisions the owner must make now.
A business owner needs to manage unpredictable events and adapt on the fly as things change. This requires understanding their longer term position and visualizing multiple scenarios.
Forecast scenarios are based on potential outcomes. Best practice is to develop a worst case, a best case, and a working forecast scenario.
The worst case should support the business through lean times. It should reflect the least sales imaginable (lowest revenue), with reduced expenses to match.
The best case should contain stretch goals for revenue, and expenses to support that growth.
The working forecast lands somewhere in the middle: realistic revenue projections, with goals built in, and expenses to support reality + growth.
An additional benefit of this comprehensive work is that if the small business needs to apply for a loan, or seek out an investor you’ve already got the financial forecast ready that these groups will need to see.
How to get started forecasting
To build an accurate working forecast, it’s best to have a software tool that eliminates the need for manual calculations and modeling. That way you can focus on the necessary inputs, (the educated guesses and business rules) and let the software guide you. You’ll also want software that allows for multiple financial scenarios and that can produce lender ready documents to accompany a loan if needed.
Further, when the crisis is over, the business owner will have a better method to manage their business and will carry it forward into the future. You, as the accountant or strategic advisor, serve as the analyst for the owner - showing them the possibilities and the effects of their decisions.
We of course recommend LivePlan for small business financial forecasting and loan prep. We train accountants to use LivePlan as a platform for long term strategic advising, but you can also use it to create quick financial forecasts to help your small business clients in need right away.
LivePlan will quickly display up to three past years of financial information, and create a starting forecast using the prior year’s data, allowing you to quickly edit from there. Once completed, you’ll be able to use LivePlan to produce financial documents for loan applications if needed.
Steps for building a worst case financial scenario
If you have not developed the three financial scenarios for your small business client, you can start with just one. In times of financial uncertainty a worst case scenario is the best place to start.
Use LivePlan, and focus on just the next 12 months of forecast, using at least the prior 6 months as a guide. Here are some steps to follow:
1. Review and Update the Following Financial Sections:
Think about these items, and work with your clients to apply your best educated guesses to each month of the forecast during the period of uncertainty.
- Revenue: Reflect the lowest sales possible during the period of uncertainty
- Cost of Goods Sold (COGS): Reduce COGS to match - with considerations for renegotiating vendor pricing and payment terms.
- Variable Expenses: Reduce variable expenses as much as possible (payroll is not a variable expense - leave it to last).
- Fixed Expenses: Analyze current fixed expenses individually and decide how to address each one. Can contracts be negotiated, rent/mortgage forbearance possible?
- Accounts Receivable (AR) and Accounts Payable (AP): Review AR and AP term changes. Can you renegotiate to collect outstanding AR sooner, or pay AP later? Reset these cash assumptions by revenue and expense line if possible.
- Disaster Relief Benefits: Apply any disaster recovery laws and regulations for things like payroll assistance, rent and mortgage forbearance, etc.
- Loans and Financing: Add modeling for loans or lines of credit as necessary.
- Payroll and Staffing: At the right time, address payroll, and any necessary reductions in force (layoffs or terminations). Staffing is typically the last thing considered, as we want to keep our staff for as long as possible, but sometimes it’s necessary to consider layoffs.
- Taxes and Benefits: Don’t forget payroll taxes and health benefit payments, also other benefits like 401k payments. These are typically modeled as a percentage of total salaries, called a burden rate. Be sure to consult state law or a human resources consultant to remain in compliance with all items related to employment.
2. Revisit and Update the Forecast:
At each step along the way, as you make entries and edits, your financial forecast should dynamically update monthly, with running profit and cash over the 12 month period. If you are using LivePlan, this will be your experience.
3. Review Profit and Cash Data:
Each time you make a change to a financial element, look at the running profit and cash figures, and help the business owner determine what other changes need to be made to create a plan they can manage.
4. Consider Loan and Financing Options:
At the right time, if necessary, a loan can be considered and modeled as part of the plan.
How to use the forecast to help your clients
The financial forecast becomes the roadmap for the business.
- Use it to guide sales goals, expense limits, and payment timing.
- At the end of a week, or maybe a month, as accounting data is recorded, compare the forecast to accounting actuals and look for variance.
- Is the business on course, or is it off course? Update the forecast as necessary and keep moving forward.
Your small business clients will continue to need help in creating and understanding their forecast, what the numbers mean, and how they affect necessary business decisions.
You don’t have to worry about making all the decisions for your clients. Small business owners are tough, and they don’t shy away from making hard decisions. They are entrepreneurs after all, but they do need to understand their numbers.
And in uncertain financial times, your analysis and feedback can be their lifeblood.
It’s important for public accountants working with small businesses to be able to support their clients in seeing a full financial picture, and bring the data, analysis, and insights about the numbers to help support them through tough times. Any accountant who can do that will have a rock solid ongoing advisory relationship.
Kathy Gregory has over 20 years of experience in business development, including: financial forecasting, strategic planning, process development, project management, and mergers and acquisitions. She has worked in public and private, small to mid-size organizations doing business development, and strategic planning and implementation, working with executives, boards and their investors. At LivePlan Kathy runs the specialized program for Strategic Advisors. She is a graduate of the University of Oregon.