Increasingly when businesses look for funding from a Bank they will be asked to provide three way Financial Forecasts.
In the past, often a simple cashflow forecast would have been sufficient, however whilst a cashflow forecast can be helpful as a guide – its ability to provide Lenders with a comprehensive overview of the future financial outlook for a business is limited!
What are Three Way Financial Forecasts?
Unlike a traditional stand-alone cashflow forecast – three way Financial Forecasts, link the projected cashflow to a Balance Sheet and Profit and Loss Statement.
That is; they show what the cashflow means in terms of margins and profits for business. Also how the business balance sheet is impacted.
Unlike a stand-alone Cashflow Projection, they are less prone to error as the assumptions used can be more accurately tested against historical performance.
Why Banks need Three Way Financial Forecasts
Bankers are financiers. They understand finance. Whilst they will have some understanding of your business and industry, their expertise lays in the area of numbers and finance.
Three way Financial Forecasts provide Bankers insights as to the future outlook of the business from a financial perspective. It puts your business into a language Bankers can understand!
Also, because the Cashflow Forecast is linked to a projected Profit and Loss and Balance Sheet it allows the Bankers (& indeed the business owner) to confirm the validity of the assumptions used in the Forecasts.
That is are:
- Margins used in line with historic margins?
- Debtor and creditor collection, and payment days, in line with what has occurred in the past?
- Projected stock turns in line with what has been the case historically?
Why business owners need Financial Forecasts!
Running a business without Financial Forecasts, is like driving down a highway using your rear vision mirror for guidance!
The reality is you don’t know what is coming toward you – you are an accident waiting to happen!
Financial Forecasts are a practical and powerful tool, business owners can use to understand the future cash needs of a business.
They can show the financial impact of things like your:
- Chosen business strategy
- Growth (every $ of sales needs to be funded)
- Internal policies and process
- Ability to service any loans
- And much more…
Crucially, they also highlight in advance, where action is required to deal with potential cashflow shortfalls.
For business owners, they are a practical tool that assist with planning and importantly, help you sleep at night!
Three Way Financial Forecasts – Build on a Solid Foundation!
As stated earlier, a major benefit of three way Financial Forecasts is that they allow assumptions used in their preparation to be tested.
For example; if the cashflow forecast was based on debtor collections of say 45 days and yet historically the reality has been 60 days, then the projected cash needs of the business will be incorrect.
This could lead to cashflow shortfalls placing pressure on everyone involved with the business – including the Bank!
Similarly, if the forecasts are based on stock turning over every 90 days, yet the reality is 120 days – this again could lead to significant and unneeded difficulties for the business.
A Cashflow Forecast that is not linked to a Profit and Loss and Balance Sheet only shows part of the picture and potentially can include serious flaws – that 3 way Forecasts can help avoid.
Involve your Accountant or Bookkeeper
Whilst there is software available that can assist with the preparation of 3 way Financial Forecasts, it is good practice to involve your accountant or bookkeeper to assist with their preparation.
This is not about abdication but delegation – you need to be actively involved as:
- You understand the dynamics of your business better than anyone
- You will be far better placed to respond to questions about the Forecasts from Lenders
- It will assist you to better understand the cashflow dynamics of the business, decisions taken and your internal policies and systems.
Summary
Whilst three way Financial Forecasts take time and work to prepare, they are a valuable tool for both business owners, and their Bankers, to understand the future outlook of a business from a financial perspective.
Unlike a stand-alone Cashflow Projection, they provide a more comprehensive insight into the business and can be tested against historical performance.
For this business owner this means any finance approved, will be based on sound financial information – reducing the likelihood of problems or covenant breaches down the track.
In my next post, I outline how to go about preparing Financial Projections, including critical elements that should not be overlooked.
In the meantime, if you would like to chat about how three way Financial Forecasts could assist your finance application, don’t hesitate to get in touch!
