Why Forecasting is the New Budgeting: Mastering Financial Strategy with Greg Crabtree

In the rapidly evolving landscape of business management, the traditional practice of budgeting is often found wanting, especially when it comes to adapting to unforeseen changes and opportunities. Forecasting emerges as a more dynamic and forward-looking approach, proving crucial for entrepreneurs, business owners, and corporate leaders who strive for strategic growth and enhanced performance.

This article, drawing from the financial philosophies of Greg Crabtree, will explore why forecasting not only supersedes traditional budgeting but also becomes an essential tool in the arsenal of modern business management.

We will decode the basics of a simple forecast model, delve into the complexities of more advanced systems, and provide practical applications to demonstrate how forecasting can lead to more informed and strategic business decisions.

Why Forecasting Supersedes Traditional Budgeting

Forecasting is a vital tool in modern business management, offering a dynamic approach to financial planning that transcends the limitations of traditional budgeting. Instead of setting rigid financial boundaries for operational spending and revenue expectations, forecasting provides a more nuanced and adaptive picture of future fiscal scenarios. This method incorporates current economic trends, past financial data, and proactive business insights to remain agile and responsive to market dynamics.

Business consultant and financial expert Greg Crabtree emphasizes the pivotal role of forecasting in achieving sound financial health and strategic growth. According to Crabtree, traditional budgeting often restricts business leaders to static, year-to-year plans that don’t account for mid-year corrections or changing conditions. When businesses fall off budget in the first quarter, they may disconnect from the plan, sacrificing performance for the rest of the year until the next budgeting cycle begins.

Crabtree advocates for a more flexible, forward-thinking approach. Forecasting, unlike rigid budgeting, supports continual adaptation through regular updates—often monthly or quarterly—based on actual results. This continuous refinement allows businesses to realign their expectations and strategies more accurately for the year ahead.

By prioritizing forecasting, companies can identify potential financial hurdles and opportunities early, allowing for smarter, data-driven decision-making that supports long-term success and agility. Instead of being bound by fiscal years or calendar increments, businesses can take proactive steps to cut out unproductive activities and focus on what truly drives performance.

Ultimately, while budgeting ties you to a set of often outdated numbers, forecasting equips you with the flexibility to adapt, grow, and achieve your financial targets. By spending less time looking back and more time planning for the future, you position your business to not just survive, but thrive amid financial uncertainties.

The Basics of a Simple Forecast Model

Forecasting serves as a vital tool in predicting the future financial health of a business, allowing leaders to make more informed decisions. A simple forecast model might look less intimidating than it sounds, yet its implications on business are profound. Let’s explore how to set up a basic forecasting model.

Interpreting the Data: Understanding What Numbers and Trends Mean for Business

Your simple cash flow model will start with the basics: revenue, cost of goods sold, and operating expenses. The five most common operating expenses to look out for are salaries, marketing, facilities. payroll taxes and benefits, and other operating expenses.

From these three numbers you can calculate the gross margin and pretax profit, also known as operating income. Gross margin is revenue less the cost of goods sold. Pretax profit is gross margin minus the total operating expenses. Many businesses make the mistake of focusing on gross margin but this number can be misleading. The most critical metric you and your company should focus on is pretax profit as a percentage of revenue. This will help you truly measure profitability.

The Roadmap from Profit to Cash: Turning Profits into Operational Cash Flow

You might see a profit amount on your books, but that doesn’t always equal the cash you have on hand. Here’s how you figure out the actual cash:

1. Accounts Receivable (A/R)- This is money that customers owe you. Check the starting A/R balance and the ending A/R balance. If you started with $95,000 and ended with $110,000, your receivables increased by $15,000. This means customers owe you more, and you haven’t received that cash yet, so it uses up $15,000 of your cash.
2. Accounts Payable- This is money you owe to suppliers. Once again you need to analyze the starting and ending balances. If you started with $20,000 and ended with $15,000, your payables decreased by $5,000. This means you paid off $5,000, so it used up cash.
3. Debt- This is money you borrowed. If you started with $50,000 in debt and ended with $65,000, you borrowed an additional $15,000, which means you have $15,000 more in cash.
4. Shareholder’s Equity- This is money the owners put in or took out. If you took out $5,000 as a distribution, it reduced your cash by $5,000.

The net change in cash can be calculated by adding these impacts together.

Total net change in cash: $8,000 (profit) – $15,000 (A/R) – $5,000 (payables) + $15,000 (debt) – $5,000 (equity) = -$2,000

So, even though you made a profit of $8,000, your actual cash decreased by $2,000.

The starting balances for each element will be the ending balances from the previous month. Estimate changes to predict the next month’s cash flow. You can use the ending totals to target and act upon. If your A/R is too high, you know to target for a lower A/R. In order to do this, you must take action; hope alone is not enough. For instance, you may aim to get customers to pay faster. Make sure you’re tough in negotiations to ensure timely payments.

In essence, understanding these elements helps you see why you might have little cash even if you’re making a profit, and it allows you to plan your cash flow better.

Driving the Forecast: Strategies to Effectively Guide Business Decisions Based on Forecasts

Once you’ve gathered all the key elements for your financial forecast, it’s time to dive deeper and expand your projections across a wider timeframe. Whether you decide to forecast on a quarterly basis, semi-annually, or even annually, the system remains versatile. As actual numbers start rolling in, you can seamlessly update your forecast with real data. This process can be quick—taking less than an hour each month.

Your gross margin calculation hinges on forecasting both your sales and your gross margin percentage. By setting a target gross margin percentage, your model can easily determine the cost of goods sold and convert that into gross margin dollars.

Operating expenses are perhaps the simplest part of the forecast. Historical data generally informs future trends, assuming there are no major changes like adding or cutting costs. Labor expenses, in particular, should be straightforward as they are tightly linked to your staffing structure.

Where many forecasters falter is in predicting cash flow. Your accounts receivable (A/R) will depend on manually inputting your days sales outstanding (DSO). Inputting your payables can be guided by your historical dealings with vendors.

Debt repayments are also an input based on either available cash or fixed payment schedules. Capital injections and distributions are direct inputs as well. Ideally, you should consider limiting distributions to tax purposes until you reach your core capital targets.

Key Metrics: Identifying and Monitoring Essential Financial Indicators

From your forecast you can calculate important financial metrics. Don’t get hung up on meeting a benchmark number, rather place the importance on the movement of the metric. For example, you should see positive trends over time. Some of the key metrics to focus on are:

• Labor Efficiency– This represents the productivity of your employees. While this number will have some fluctuations you should keep an eye on it and make sure it isn’t consistently trending downwards.
• Accounts Receivable DSO- This is calculated by A/R divided by Average Daily Sales. Average daily sales is a simple calculation: This month’s revenue multiplied by 12 then divided by 365. Take caution when making this calculation as it can be distorted by seasonality if you use annual data. It’s best to look at the last two months of revenue.
• Core Capital – Your core capital target is two months of operating expenses with nothing drawn on your line of credit. If you have to pay your cost of goods sold before you get paid, include it in the calculation.You shouldn’t be taking any distributions until you’ve reached the core capital target.

By embracing these foundational elements of a simple forecast model, businesses can start to move away from traditional budgeting and begin leveraging predictions for more dynamic financial planning and management.

The Complex Forecast Model

In the realm of financial management, understanding the relationship between your Profit and Loss (P&L) statement and balance sheet is crucial for creating a complex forecast model that truly reflects your business’s financial health. This integration allows for a comprehensive view of current financial performance as well as future projections, highlighting not only profitability but also the overall stability and sustainability of your business. The advanced cash flow model allows a more comprehensive picture of data over a longer period of time and allows you to do a rolling-twelve calculation for your P&L so you can calculate your key key metrics.

Connecting Profit and Loss (P&L) to Your Balance Sheet: Why it Matters

A P&L statement illustrates the income and expenses over a period, showing how profitable your business has been. Conversely, the balance sheet provides a snapshot of your company’s assets, liabilities, and equity at a specific point in time. By linking these financial statements, you create a dynamic model that tracks cash flow movements and their impacts on your financial standing. This practice:

• Shows the operational effectiveness by relating profits (or losses) to changes in assets and liabilities.
• Helps identify areas where profitability does not translate into cash flow, prompting further analysis and strategic adjustments.
• Supports better capital management decisions by illustrating how operational choices affect equity and debt levels.

The Importance of Rolling 12 Data: How it Reveals Mega Trends in Business

Rolling forecasts, specifically those utilizing rolling 12-month data, adapt continuously to include new monthly data as the oldest month drops off. This method offers several advantages:

• Provides an updated forecast that adapts to recent business changes and market conditions.
• Smoothens out anomalies caused by seasonal variations or one-time events, giving a clearer picture of long-term trends and cycles.
• Enhances strategic planning by constantly reflecting the most current 12 months, aiding in identifying large scale trends that affect business operations and financial strategies.
• Reveals important trends related to gross margin, salary cap, labor, and pretax profit. Based on the trends revealed, you can make strategic decisions.

Using these elements of a complex forecast model, businesses can align their operational strategies more closely with their financial goals, anticipate potential challenges, and maneuver through financial landscapes more adeptly. This forward-looking approach is essential for maintaining competitiveness and achieving sustainable growth in today’s dynamic business environments.

Addressing Common Challenges in Forecasting

Forecasting in business is critical in steering company strategies towards success, yet it’s often fraught with challenges that if unaddressed, can undermine its efficacy. One main issue is the collection of accurate data, which is essential as the reliability of a forecast depends on the quality of data fed into the forecasting model.

Avoiding Over-Complexity in Forecasting Models

Another primary issue lies not in the accuracy of data alone but in the complexity and manageability of the forecasting model itself. Many businesses fall into the trap of creating overly detailed and intricate forecasting models, which become burdensome to update and fail to provide tangible value. Simplification is key—focus on developing straightforward forecasts that offer essential insights without excessive detail.

Beyond Profit and Loss Forecasting

Another common challenge is the mistake of limiting forecasts to just profit and loss statements. A holistic approach should integrate cash flow and balance sheet items to provide a well-rounded financial perspective. Many entrepreneurs make the mistake of only accounting for profit and loss. However, the balance sheet and cash flow report should reasonably predict the following:

• Account Receivable
• Inventory
• Accounts Payable
• Term Debt Repayment
• Automatic Withdrawals
• Repayment of Line of Credit

Embracing a Rolling 12-Month Forecast

Moreover, structuring forecasts rigidly around the fiscal year can be limiting; instead, adopt a rolling 12-month method. This allows for continuous updates and a more dynamic view of future performance, accommodating market shifts and business changes.

Facilitating Easy Forecast Updates

Lastly, ensure that your forecasting model is designed for effortless updates throughout the year. This flexibility ensures your forecasts remain relevant and reflective of current realities. In order to create an easy process for clients to update their forecast Greg Crabtree incorporates the following into his forecasts:

• Store the source data in one tab
• Presentation of data needed is on a separate tab that pulls from the source data to avoid seeing the input data on the presentation
• Avoid using blank columns as spacers because they make it harder to copy date to the next column when updating
• The current month of actual data can be dropped in and rolled forward with every month end close.

Implementing these simplified, dynamic practices can exponentially improve forecast reliability and relevance. Regular updates, scenario planning, and integrating feedback on forecast accuracies can lead to substantially better-informed decisions and improved market competitiveness. By addressing these challenges strategically, businesses can enhance the accuracy and utility of their forecasting efforts.

How to Transition from Budgeting to Forecasting

Transitioning from traditional budgeting to a more dynamic forecasting model can transform how you approach financial management in your business. This shift not only enhances strategic decision-making but also aligns your financial planning with the agility required in today’s business environment. Here are practical steps and tools to facilitate this transition:

Steps to Shift the Financial Planning Focus

1. Educate Your Team: Begin by training your team on the benefits and processes of forecasting. Understanding the ‘why’ behind forecasting empowers them to fully engage with the shift.
2. Evaluate Your Current Financial Processes: Assess your existing budgeting method and identify areas where forecasting could provide clearer insights or where budgeting restricts your flexibility and responsiveness.
3. Set Clear Objectives: Define what you aim to achieve with forecasting, such as improved cash flow management or better alignment with market conditions. Objectives should be specific, measurable, attainable, relevant, and time-bound (SMART). This can also be referred to as targeting.
4. Start Small: Implement forecasting in a small, manageable area of your finances. This could be a particular product line or a single market segment. Evaluate the outcomes and scale gradually.
5. Regular Review and Adjustments: Unlike static budgets, forecasts should be reviewed and adjusted regularly. Decide on a review cycle (monthly, quarterly) and stick to it to ensure your forecasts remain relevant.

Tools and Technologies to Support Effective Forecasting

• Financial Management Software: Utilize tools like QuickBooks, Xero, or Oracle for real-time data management and cloud-based access to financial information, enhancing the dynamism of your forecasting.
• Spreadsheet Software: While more advanced tools are available, Excel or Google Sheets can be a good starting point for crafting forecasts, offering flexibility without significant upfront investment. You can find our Profit & Loss Comparison Template here.
• Dashboards and Reporting Tools: Software like Tableau or Microsoft Power BI can help visualize trends and present forecasts in an easily digestible format for stakeholders.
• Collaboration Tools: As forecasts require regular updates and inputs from different departments, tools like Slack or Microsoft Teams can facilitate the necessary communication.

Making the move from budgeting to forecasting represents a significant step towards a more proactive and informed financial strategy. By implementing these steps and leveraging modern tools, you can ensure a smoother transition and a stronger, more adaptable financial plan.

The Role of Forecasting in Achieving Long-term Business Goals

By aligning forecasts with business growth strategies, organizations transform their financial planning from reactive to proactive, positioning themselves for future success. Effective forecasting enables business leaders to set realistic growth targets and devise strategies to achieve these objectives by assessing market trends, understanding industry shifts, and anticipating customer needs. This ensures that every aspect of the operational plan supports the overarching goals, allowing for necessary adjustments in a constantly changing landscape.

Strategic Decision-Making & Operations Enhancement

Forecasting empowers executives to make well-informed choices about investments, resource allocation, and operational adjustments. With clear visibility into future revenue streams and potential financial risks, decision-makers can strategize effectively, ensuring optimal outcomes for their businesses. Accurate forecasting allows for more efficient resource management, inventory optimization, operational cost control, and balanced investment across various business areas.

Expansion through Forecasting

For businesses eyeing expansion—whether in geographic footprint, product lines, or market penetration—forecasting provides a strategic framework for managing growth. By predicting future revenue streams and evaluating potential risks associated with expansion efforts, companies can align their growth with financial stability and market opportunities. This cautious yet ambitious approach minimizes financial risks while maximizing the probability of successful expansion.

Risk Mitigation

Another crucial aspect of forecasting is its role in risk management. By foreseeing potential downturns or financial challenges, companies can formulate contingency plans. This forward-thinking practice prevents panic-driven decision-making, fostering a stable business environment even in volatile market conditions. It also allows companies to set aside reserves or secure financing in advance, cushioning the impact of unexpected financial strains.

Promoting Business Agility

Maintaining a proactive stance in financial planning is essential for today’s businesses. Forecasting encourages this by integrating emerging trends and making iterative improvements to financial strategies.

The adaptive nature of forecasting allows businesses to remain competitive in fast-paced environments by supporting continual adjustments based on real-time data. This method not only mitigates risks but also enhances potential for capitalizing on unforeseen opportunities. By integrating emerging trends and making iterative improvements to financial strategies, forecasting encourages proactive financial management, beyond the limitations of static budgeting.

Forecasting’s strategic advantage is evident in its capacity to drive business growth and adaptability. By anticipating potential future states and outcomes, businesses can plan more effectively for expansion, allocate resources efficiently, and respond agilely to both challenges and opportunities. The insights garnered through effective forecasting are invaluable in shaping strategic initiatives and long-term planning, underscoring its importance as a central element of financial management in any ambitious business setup.

Shifting to Forecasting

As we’ve explored, the shift from traditional budgeting to dynamic forecasting is not just a trend but a strategic necessity in today’s fast-paced business environment. By understanding and implementing the principles of forecasting, you can steer your business towards sustainable growth and operational efficiency.

If you’re ready to transform your financial approach and elevate your business performance, explore more of Greg Crabtree’s insights in his books Simple Numbers, Straight Talk, Big Profits and Simple Number 2.0.

Additionally, you can bring your business to new heights with one of Greg’s keynotes or workshops.

Embrace the change, enhance your financial acumen, and lead your business with confidence. Make smart, strategic decisions based on robust forecasting. Reach out to Greg Crabtree today, and start your journey towards financial mastery and exceptional business growth.