Most companies prepare an annual budget. Some also update their forecasts throughout the year or prepare longer-term forecasts.

There are many reasons to forecast and many different approaches to doing it. But there is one important point that is often overlooked:

A forecast is not a prediction. It is a tool for making better decisions.

Assuming your forecast includes a pro forma P&L and balance sheet—or at least a projection of your cash balance—it should represent either your financial plan or your best projection of revenues, expenses and cash activity based on what you know and believe at the time you prepare it.

But can you now predict exactly how much revenue and profit you’ll have? How much cash you’ll have at the end of each period?

No.

A forecast is based on assumptions, not known facts. You can say, “If these assumptions hold, we expect revenue, profit and cash to be X, Y and Z.”

That’s very different from predicting that X, Y and Z will actually happen.

So, if a forecast isn’t a prediction, how should you use it?

First, use it as a roadmap.

It tells you what your financial results should look like if you follow the plan and your assumptions hold.

Second—and more importantly—use it to make decisions.

For example, suppose your growth plan calls for hiring several salespeople. Their salaries, draws, travel and entertainment expenses and other costs are included in your forecast. But the forecast shows that following the plan will cause you to run out of cash.

That’s not a reason to throw out the forecast.

That’s the forecast doing its job.

It tells you that you have a decision to make before you commit to the spending.

You might find additional financing, hire fewer salespeople, slow the pace of hiring or change another part of the plan.

Or suppose you’re planning to launch a new product or service, but the forecast shows that the incremental gross profit margin will be very low—or even negative.

Again, the forecast has identified a decision that needs to be made.

You might delay the launch, change your pricing, reduce the incremental costs or modify the product or service before putting it on the market.

The same applies to raising capital.

If you plan to raise $1 million in equity, but your forecast shows that you’ll run out of cash in six months, you have several choices. You could raise more than $1 million, spend the money more slowly, accelerate the fundraising process—or some combination of the three.

The point isn’t that the forecast tells you what will happen.

The point is that it helps you understand what could happen if you follow your current plan—and what decisions you may need to make as a result.

So how do you use the forecasts you develop?

Do you look at strong projected results, say, “This looks great,” and go back to work?

Do you look at weak projected profit or cash flow and simply tell the sales department to sell more?

There isn’t one right answer.

But there is a wealth of information in a forecast that looks at both profitability and cash flow. The real value comes from understanding why the numbers look the way they do, what could cause them to change and what options you have.

That’s where a good CFO—full-time or fractional—can add significant value. A CFO can help management understand what the forecast is telling them, challenge the assumptions behind it and evaluate different alternatives before making important decisions.

A good forecast doesn’t tell you the future.

It helps you make better decisions about the future.

But sometimes the best decisions require more than financial analysis.

And that’s where a Compass Advisory Council brings successful business leaders into the conversation—people who can challenge assumptions, provide different perspectives and help develop a game plan for growth that considers the financial implications and cash constraints of the plan.

If you’d like to talk about forecasting, how to use it to make better decisions, or how a fractional CFO or Compass Advisory Council could help accelerate growth in revenue, profits, cash flow and value, reach out to me at larry@larrylevy.co or schedule a time to talk with me here: https://calendly.com/larry_levy/meeting