This blog was guest-written by Drew Murphy. Drew is the co-founder of FP&HEY, a community for FP&A professionals to learn skills, grow careers, and much more. He has over 20 years of FP&A experience, is a former CFO, and is an avid vintage baseball player.
How to Profit Forecast without a Crystal Ball
Today’s post is on how to profit forecast without a crystal ball.
You will learn:
- Why profit forecasting is important to your company
- The role FP&A plays in profit forecasting
- What data is needed to create a profit forecast
- The steps to create a profit forecast
- How to communicate profit forecast results
Like life, profit forecasting can be complicated. But if you’re a psychic, predicting your company’s financial future is easy. (Wouldn’t that be great?) For the non-psychic FP&A crowd, you too can predict your company’s financial future. Here’s how!
What is profit forecasting?
Let’s talk about the weather. ⛅🌧
What’s the weather and temperature where you are right now? Did you expect that type of weather today? Most people check the weather every day. Why?
Knowing the weather helps us make informed decisions like:
- Is it warm enough to wear a T-shirt and no jacket?
- Is it cold enough to play pond hockey?
- Should I travel in my car or stay home and avoid an expected snowstorm?
Simple information in a timely manner helps us make informed decisions. But remember, weather forecasts change and are never 100% right.
Weather forecasts typically go 10 days out. And if you noticed, the further out the forecast the more often it can change. 10 days from now the forecast could call for light snow. 8 days later that light snow could turn into a major snowstorm or no snow at all. We never know with 100% certainty what the weather will be until we live out the day. And that’s ok!
The weather forecast gives us constant awareness. We can then prepare ourselves to thrive in all types of weather. Predicting the weather for the public is like profit forecasting for your company. Profit forecasting helps businesses prepare for all types of financial weather by understanding how much revenue, profit, and cash a company will generate.
But why does any of this matter?
Why profit forecasting is important
Does your company know how much revenue, profit, and cash it will generate:
- This year?
- This quarter?
- This month?
It should.
This is why profit forecasting is so important. Your business wants to grow, especially one in a growth phase (such as startups).
And growing requires having goals, being prepared, and executing. Think of it like a car road trip you are about to go on:
- What’s your destination?
- How far do you need to go?
- What routes could you take?
- How fast do you need to get there?
- How much fuel will I need?
- What type of vehicle should you drive?
What if you didn’t know the answers to these questions going into your road trip? Might be ok to start, but things will unravel quickly. Profit forecasting helps prepare businesses to reach their desired destination.
Your business has its own road trip to go on and destination to reach:
- What revenue do you want to achieve?
- When can you achieve positive cash flow?
- What initiatives will fuel our customer growth?
- Can we hire double the people and maintain profitability?
- What risks do we see and what options can mitigate them?
Remember, the goal of a profit forecast is NOT to be 100% accurate. The goal is timely visibility with the ability to make decisions to course correct. Now, let’s fire up the spreadsheet and start forecasting.
How to create a profit forecast
The best profit forecasts are done monthly and completed within 2 business days.
Yes, two days. We’ve done this before and know it’s possible. 😉
It’s a big challenge and not many companies pull this off. It requires a combination of:
- Strategy alignment
- Clean data
- Tight business partner relationships
- Clear and concise communication
Let’s dive into the details.
Define your business goals
Let’s say your company wants to double revenue next year. And at the same time generate positive cash flow. These are goals that can be measured. These goals give you the superpower of autonomy.
As you create your profit forecast you can guide the business to reach them. All without constantly emailing your boss asking if it’s ok to have negative cash flow.
Talk to your leadership and get your goals aligned and formally documented.
Gather data and assess with business partners
FP&A is darn good at numbers. We STINK at marketing, selling, recruiting, and engineering. If you are good at all these things, then you are a swiss army knife of talent. The reality is we need revenue and expense data. This data must be clean AND understood. Creating a constant flow of information with business partner reviews helps us do just that.
Sometimes that requires weekly meetings, sometimes monthly. Just keep the communication consistent and be helpful. If your company uses Slack, try creating dedicated channels to stay connected. Here are the departments that have the largest impact on profit forecasts and the questions you should know the answers to:
- Sales: how much new and upsell revenue can we generate?
- Customer Support: how much revenue churn can we expect?
- Human Resources: how many existing and expected people count?
- Marketing: how much will be spent on advertising and branding?
- Engineering: how much cash is required to purchase equipment and software?
🔥Business partner tip #1: Help Sales upsell using white space analysis
🔥Business partner tip #2: Help Marketing spend to their budget using a PO process
🔥Business partner tip #3: Help HR understand the financial impact of attrition
Now that you have data and understand what it means, add it all up. How much profit did you generate?
Consolidate the data and create options to get back to your targets
This is your big moment! You have all your updated data, and you spoke with all your business partners. You add it all up, and you realize something…. Your profit is DIFFERENT than what you originally forecasted.
Congrats, you were wrong. Guess what? 100% of all profit forecasts are wrong. Understand what options you have to get back to your original profit goal. Here are some things you can do:
- Move equipment purchases into different periods
- Update your new hire target start dates
- Create a SPIFF (Sales Program Incentive Funds) to incentivize sales to sell more
- Change marketing spend mix to maximize desired results
- Run a promotion for existing customers expected to churn
All of the above require alignment from your business partners. Good thing you have tight business partner relationships to make this easy. This will help you understand how decisions impact your current profit forecast.
Now you're ready for the big show. Let’s tell your boss the latest financial forecast results with options influence.
Communicate profit forecast results and get decisions made
You can start the conversation by saying “Guess what boss, I was wrong again”. Depending on your relationship, this can be hilarious or career-limiting so assess your own situation accordingly.
Your boss and CFO want the company to succeed, so help them do just that. Keep it simple and follow these steps:
- Start with the profit you expected from the forecast you presented last month
- Compare the current profit you expect with last month’s forecast
- Provide commentary on what changed and why
- End with options you have to close the profit gap versus the expected target
🔥Tip: Use waterfall charts to visually show the above changes.
Every leader is different. Some like details, others like getting to the point. You’ll learn how your leadership operates and constantly adjust your communication approach accordingly. Get sign-off on certain options and communicate them back to your business partners to execute. That’s how you help a business hit its targets in two business days.
Conclusion: You helped your company crush it
You just helped your company achieve its financial goals. Bonuses will be paid and promotions will be given. Best part, it wasn’t complicated and you did it by creating a profit forecast. Keep talking to your business partners and learning how your company operates.
Keep telling yourself two things:
- 100% of profit forecasts are wrong.
- The goal of a profit forecast is timely visibility with the ability to make decisions.
Go crush your company’s next earnings release. 👊
How do you feel now? Ready to manage your company’s profit forecast process?
Visit FP&HEY to get more exclusive FP&A tips, tricks, and resources. Now go have fun making an impact on your company and your career!
Cheers,
Drew & Yarty
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