Forecasting is a technique which allows the accountant to reasonably estimate the future performance of a business.
It can be used on sales, costs, capital and cash, anything really from which you can discern financial information.
Usually as accountants, we are interested in what our balances are at year end for the profit and loss statement. We may be interested in shorter-term forecasting if we are working out future liquidity when cash forecasting.
The approach is broadly the same. Firstly line up future periods across the top of an excel spreadsheet spanning the timescale you wish to look at. Then, in the rows we need to place all the factors that have an impact on the final figure in question. In order to find out what these parameters are, we need some intelligence. This can be gained by speaking to experts in this area, service directors or front line staff in a larger organisation for example. Otherwise research must be done, insight into the sector, this can be done online these days.
In order to fill in the blanks of the numerical values it is usually best to "straight-line" existing data. If you are looking at a year end forecast and you are at Q1, you could take the year-to-date balance at Q1 (month 3) and divide it by 3 to arrive at a monthly year to date run rate and times by 12 to do a basic forecast for your outturn position. Or you could add the final 9 months of the prior year and multiply by an inflator. Of course this would have to be tailored for known events that mean that the final 9 months will not be simply the first 3 extrapolated: seasonality, losses of contracts, advertising campaigns, investments & disinvestments etc...
Once you have a robust model with a straight line forecast underpinning some intelligent assumptions you could add a separate list of risks and mitigations in a bid to try to control the outcome you are seeking. These could be probability-weighted so that if you are being taken to court for a sum of £500k and you believe it is 50/50 that you will win/lose the case, you could ascribe a value of £250k (0.5*500) to your forecast.
The trick with forecasts is to regularly review them, update for new information and adjust assumptions. Forecasting is more meaningful to businesses than simple variance analysis or prior year comparisons as it helps to shape the direction and strategy of the business in a forward-looking way and should inform decision-making.
Next week we'll look at something more tax-related and relevant to contractors in the current climate: IR35 (disguised employment).