OK, you’ve taken the plunge — gone out on your own — told the boss to stick it and set up your own business. You’ve left the corporate world behind and you’ll be playing by your own rules from now on! No more management hierarchies, no boring meetings, no budgets and no getting sign-off to spend any money. From now on, you’re your own boss and no one can tell you what to do.
The first thing you need to do in order to take the amazing idea in your head and turn it into a fully-fledged company is to raise capital, and the first piece of advice you’ll get is to create a business plan and a forecast. If that sounds like an awful lot of hard work, you’re right. If you don’t even know where your next pay cheque is coming from, how can you be expected to have foresight years ahead on the performance of a company that exists only in thin air? It also sounds suspiciously like a budget — something you thought you’d left behind in the corporate world.
A Budget and a Forecast are not the same thing
Let’s start out by getting one thing straight — a budget and a forecast are two completely different things. From an entrepreneur’s perspective, forecasts are good and budgets are bad.
So why are budgets bad? A budget by nature is static; it is very detailed and is predominately used as a gauge for measuring actual spend and revenue in management reporting. It focuses heavily on expenses and, most importantly, setting caps on those expenses. They are a great tool to keep managers in check, but are they really necessary in a startup company? No. A suite of management reports is not a priority just yet.
At this stage in the business cycle, you don’t have much to budget. Are you going to cap yourself, the only employee to a specific marketing budget? What happens if you realise a few months in that you need to double your print advertising and cut television ads? I guess no bonus for you — you violated the budget after all!
So a static budget is pretty much useless at this stage. When you get a few years into your venture, have multiple departments and managers, then you can hire a financial analyst to create a budget to keep everyone in check and tie their bonuses to performance.
Before you start celebrating your reprieve from budgets, let me explain that while you don’t need to budget for your startup, you do need to forecast. By comparison, a forecast is much more relevant to a startup. If built properly, a forecast will be relevant, flexible and dynamic. It usually extends to several years and, unlike a budget, is less detailed and can be updated regularly to reflect the changing nature of the company.
Why we hate Forecasting
There’s no way around it I’m afraid. Investors not only want a forecast, but it needs to be detailed, accurate, conservative and several other adjectives as well.
Are you ready to admit defeat yet?
Not having a boss is great, but in reality, if you need investors, you’ll always have someone to whom you are accountable. Did they forget to mention that part when you were encouraged to follow your dreams and live the life of a freewheeling entrepreneur?
You’re not alone. No normal, sane person enjoys building a full five-year forecast (even someone like me who lives and breathes this stuff). If there’s a choice between using Excel for ‘real’ billable work and sitting down to spend hours on forecasting my own business, I know what I’ll be doing.
Admittedly, Excel and Finance are my first loves, but most entrepreneurs are not finance-oriented people. Give them a choice between doing a Business Activity Statement (BAS) and clearing out the filing cabinet and the filing will win hands down.
Entrepreneurs are often creative, non-corporate types and the mere act of opening up a spreadsheet goes against every principal they stand for. Having to decide exactly how many employees the company will hire, what the marketing budget is, how to manage the burn rate, etc., can be a daunting prospect.
If forecasting is so disliked, why does anyone bother? It’s your company; you can do whatever you want! That is part of the reason you left your day job… the freedom of being an entrepreneur. No one can force you to do anything any more. Building a financial model is probably at the bottom of your list of tasks, right next to offering to do your friend’s tax returns out of the goodness of your heart.
Well, before you get too excited about the idea of not doing things just because you don’t want to, you may want to consider the purposes of the forecast. I wouldn’t uninstall your copy of Excel just yet.
Why you need to forecast
There are two really good reasons to have a forecast. Firstly, any investor you approach will want to see one, and if you don’t have it, the door is closed. End of story.
Secondly, as much as you hate the idea of creating one, you need the forecast. You may not want the forecast, but you do need it. It’s like going to the dentist: it’s for your health, even if it can be a slightly painful or unpleasant experience. Imagine that freshly cleaned teeth feeling — that’s like the feeling of satisfaction you’ll get when you’ve got a proper financial forecast in place.
An interesting thing happens once you’ve gone through the painful process of producing a well-built forecast: you are now in total control. How easy is it to change the projected revenue from one million to one and a half million? A few seconds and now your company just had a 50 percent boost! Cut a few expenses and your original profitability has more than doubled. It’s a great feeling to be able to ‘play God’ with the profits and valuation of your company.
Remember that if Excel is really not your thing, and you don’t have your own in-house finance person, you can always outsource the process. If you can afford it, of course. Either way, you need to own it, as no one can replace your expertise on building the model inputs and assumptions.
Pros and cons of Forecasting
So… apparently you need to create a forecast to satisfy any potential investors and for your own use. Still not convinced? Let’s explore the pros and cons of creating this legendary forecast.
- Promote forward thinking. A forecast will force you to think about the future and where you want the company to be.
- Help identify short-term problems. If once you complete your forecast you notice a negative cash balance starting in month three, you may have to rethink the forecast or your funding plans
- Help get a global perspective on how to allocate resources. You now get a better sense of how bumping the marketing budget by 100 percent may mean cuts in other areas that you can’t now ignore.
- Create goals and targets. Having it all on paper and in front of you can help you to really plan and see what needs to happen to control expenses and ramp up revenues.
- Time-consuming to create.
- Can cost money to hire someone to create. An obvious deterrent for cash-strapped startups
- Forecasting can be a complete guessing game during the early stages.
- Entrepreneurs still not convinced of the necessity of a forecast, so do half-heartedly. If you aren’t going to do it right, then is it really worth it?
- You build it knowing it’s going to change three months from now anyway. A reality of life, unfortunately. Forecasts should be regularly revised.
Once you have your forecasting accurate, think about taking it to the next level. Build a rolling forecast, something that can be adjusted and modified monthly as your company performs (or underperforms) the forecast. Sales up and salaries down? Great, now force yourself to open that Excel file once again, save a new version, and update the pending forecast based on what is actually happening.
So, what have you got planned for this afternoon? Take a deep breath, open up Excel and get ready for hours of fun!
Danielle Stein Fairhurst runs Plum Solutions, a Sydney-based consultancy that specialises in training and consulting in Financial Modelling & Analysis.