My 13-12-5 Forecasting System
Every business should spend a larger amount of time looking forward than backward. When it comes to their numbers, most small businesses don’t do that. The number of businesses with solid forecasts that are up to date and that they have faith in is very low.
Why is this? Well, Forecasting is complex. It can be more art than science at times. It can be overwhelming knowing where to start and incredibly time-consuming - no surprise that most business owners are not doing this. You need the support of an expert.
The further out in time your forecasts are, the less likely they are to be accurate. As soon as you get beyond 1-2 years, it’s almost impossible to predict what will happen accurately. This doesn’t mean that you shouldn’t use them, though!
Without Forecasting, you are missing a huge opportunity. It empowers you to make better decisions, helps you mitigate risk and acts as a roadmap to reach your goals.
Forecasting can come in many different formats and timeframes. Here is the rhythm I use to get the right balance. The 13-12-5 Cash Flow System:
13 Week Cash Flow
If you run out of cash, the business dies. Simple as that.
The shortest-term forecast I use is also one of the most important.
A constantly rolling 13-week cash flow forecast shows me exactly what will come in and out of my bank account over the next 90 days.
It is relatively easy to prepare because there is very little guesswork involved. You should have a pretty good idea of the actual money flows over the next few weeks and not be relying too much on high-level assumptions.
The forecast should be based on actual invoices and bills you have outstanding; therefore, it needs to be driven from your bookkeeping system - which must be up to date and accurate first!
You can change this frequency depending on how tight the cash flow is. In very tough times, this will move to a daily forecast.
At the end of each week, check the accuracy of the forecast, make adjustments for any new information you have and roll it forward one more week.
12 Month Budget
As you approach your new company year, you should start working on the Budget and Forecast for the next 12 months.
Budget and Forecast are often mistakenly treated as interchangeable, so let’s first clarify what they mean.
A Budget is set in stone and shouldn’t change, whereas a Forecast is flexible and constantly shifting to show you where you will end up based on what’s happened so far.
If we use a car metaphor, the Budget is the old-school set of printed directions to your destination, and the Forecast is the Sat Nav with traffic updates - The forecast route will change, and your arrival time will be updated as you drive.
12 months is the longest timeframe in which you can expect to have a reasonable idea of what your numbers might look like. This is why we use this as a Budget.
Once the Budget has been set for the year ahead, it is shared with the team and used as a roadmap to show us the way through the next 12 months.
Every month in our management accounts, we will look at how we performed against the Budget.
The Updated Forecast
Every Quarter, we look at the Budget for the remainder of the year, and based on the data and new information available, we will update the Forecast to show where we now expect to land at the end of the year.
This means we will have two projections for the same period. The original Budget locked in at the start of the year and the latest Forecast showing how close we will be to those figures - both are vital.
5 Year Model
A high-level view of how the business might look over the next 5 years is one of the trickiest to pull together.
Whilst you will use some historical data (unless you are a brand new startup) to influence your decisions, most of the assumptions you make need to be tested.
This is where you can start to be more creative with your financial strategy and build in various scenarios. For example, are you still profitable if your Client Acquisition Cost doubles? What happens to your sales forecasts if we double the price or churn increases by 10%?
The key to building a good model is to understand the whole business, beyond just the financials, and identify the key drivers of the whole strategy.
As well as being extremely powerful for high-level strategy and decision-making, it is a must-have if you plan to bring in investors or be involved in any M&A activity.
Preparing Forecasts
There is no way I can cover the ins and outs of how to build forecasts yourself in this post. There are whole sub-sections of our profession built around this topic alone.
There are a few tips I would give here:
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Get an expert to help you - obvious and potentially biased, but if you make decisions using incorrect forecasts, you could be in big trouble.
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Be involved in the detail - most owners could have a good go at the 13-week cash flow forecast. It needs intimate knowledge of where your business is at (only you have this) and is relatively simple to prepare. Ask me for a free Excel template.
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Do not attempt a 5-year model - this is hard enough for most experts to get right, and you are very unlikely to be able to build this correctly.
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Profit does not equal cash - you must understand how the cash flow, P+L, and Balance Sheet all interact, and your longer-term forecasts should all be 3-way, i.e. all three.
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Don’t get too hung up on software - This is the one area I still use Excel. I have a forecasting tool for my 12-month Budget and a different one for the 13-week cash flow, but my modelling is all done in Excel, and you can use Excel to keep things simple.
The bottom line here is that nailing your numbers game is all about looking ahead rather than just looking back. It might seem a bit daunting, and it’s certainly a challenge, but it’s crucial to tackle it head-on. Don’t shy away from forecasts - embrace them.
I get it, it’s tough, but with the right help and tools, it becomes far less of a beast.
Remember, understanding your future financials is like being given the keys to a time machine. It enables you to make better decisions today for a more successful tomorrow.
About the author
Luke Desmond
Fractional CFO for Tech, eCommerce & SaaS. CEO @Crisp_Acc provides virtual finance functions. Co-Founder @getvaulta SaaS Startup for accountants.