A Monthly Operating and Financial Forecast is a critical execution tool that allows an executive team to regularly check if the company is on or off course for their annual plan. By breaking down and tracking actual results against the expected monthly changes in volumes, revenues, costs, and cash, your team is enabled to make frequent, necessary decisions to keep things on track. This forecast, based on your annual targets, also enables your team to validate that your initial one-year targets are financially feasible given the plan's assumptions. A feasible plan is an executable plan. The forecast should also reflect any major planned investments, linking them to the annual priorities for change, improvement, and growth based on the company’s Number One Addressable Challenge for the year. So, how do you go about building a Monthly Operating and Financial Forecast? There are four key elements of an effective forecast:
Let’s go through each one. And feel free to contact me to access the Monthly Operating and Financial Forecast template I use with clients. Or complete the form in this article. Widget-based We call this a Monthly Operating and Financial Forecast because it forecasts more than just the monthly financial results. The financial projections are based on the expected monthly volume of business, which we call widgets. This is whatever unit of measure your company uses to track business flow. It might be the number of orders, customers, items, subscriptions, users, hours, square feet, etc. Whatever unit consistently drives both revenues and costs. A common, but problematic, approach to forecasting is to adjust last year's financial statements by a rough percentage reflecting expected growth. This is problematic because:
By basing revenue and cost forecasts on the number of widgets sold, produced, delivered, and supported, and using both a price per unit and cost per unit, the forecast enables the team to easily review whether pricing and costs per unit can be improved. Effective structure A Monthly Operating and Financial Forecast should present the key monthly numbers that empower the CEO and executive team to make timely decisions to improve financial results. This requires a specific structure for the financial statements, as suggested by financial management expert Greg Crabtree, author of Simple Numbers, Straight Talk, Big Profits. In the income statement, the structure includes: Gross Profit: Calculated from Revenue minus Cost of Good Sold, which are based on units sold, price per unit, and direct (outside) cost per unit. Gross Profit is a key number for assessing buying effectiveness. Gross Profit is more important than Revenue because, aside from telling you how effective your buying is, it tells you how much money the company has to work with internally to get to its Net Profit. Note that the number of units, price per unit and cost per unit are the real levers to improve gross profit. Contribution Margin: Calculated by subtracting Direct Labour (cost of employees who produce and/or deliver the good or service) from Gross Profit. This is a critical number that must cover all overhead and make a sufficient net profit. Direct Labour is a key lever for improving profitability through optimization and increased productivity. Operating Expenses (Overhead Costs): For clarity and ease of consumption, roll these up into big buckets, such as: Facilities, Marketing, Management and Administrative Labour, Payroll Taxes & Benefits, and Other Operating Expenses. Sales Labour may be another important big bucket for your company. The main levers here are those large cost categories, particularly management and admin labour. Net Operating Income (EBITDA): Subtracting total Overhead Costs from the Contribution Margin yields Net Operating Income, also called EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). This is the ultimate barometer of day-to-day profitability, setting aside debt servicing, taxes, and asset depreciation, which can vary widely depending on how assets and liabilities are managed. If your company has multiple products or product lines, then revenue and gross profit may need to be broken out for each, as well as direct labour and contribution margin if these vary by product or line. This structure provides the executive team with clear visibility into the key numbers and levers for financial optimization, and allows for the calculation of standard ratios like Gross Margin, Labour Efficiency Ratios, and Expense Ratio for external comparison. Forecasting cash As Greg Crabtree famously said, “Revenue is vanity, profit is sanity, but cash is king!” Cash is the oxygen that fuels a business. Maintaining a healthy cash balance is essential for survival and confidently making planned investments. And a clear monthly cash balance forecast verifies the true feasibility of your operating financial plan. Net Operating Profit is just a number on paper, but a company's actual cash situation is often very different, being heavily influenced by inventory, accounts receivable, accounts payable, and financing activities. Forecasting cash requires a keen eye on timing: the flow of sales, inventory purchases, production, delivery, and invoicing. For example, a sale might occur in month one, production in month two, delivery and invoicing in month three, and payment in month four. Understanding the timing of these outflows and inflows is crucial for maintaining a healthy cash position and finding ways to optimize cash flow by speeding up the cycle. A collaborative effort Many executive teams assume creating the Monthly Operating and Financial Forecast is Finance & Accounting’s job. While they lead the process, building a realistic and useful forecast requires collaboration across the entire executive team, guided by the annual company plan. Each leader must provide inputs on how expected volumes will drive revenues and costs, and the timing of those revenues and costs, on a month-by-month basis. Forecasted units impact various areas, from marketing spend to sales, production, delivery, and post-sale support, each with different timing. Only the respective leaders and their teams can provide these numbers, along with expected pricing improvements or efficiency gains aligned with the company’s annual priorities. Furthermore, each area needs to plan and estimate costs for their investments in various initiatives. When starting with a CEO and executive team and having them flesh out their One Page Strategic Plan and annual plan, we suggest beginning with a 12-month Monthly Operating and Financial Forecast prepared annually. After this is well-established (one or two years), we suggest progressing to a 36-month forecast prepared annually, and eventually to a 36-month rolling forecast (i.e., updated and extended monthly). This progression builds the team's ability to confidently predict results and optimize execution to hit their three-year targets.
If you are a prairie CEO who wants to grow a thriving company, team and life more quickly, more easily and with less stress and headache, please contact me here.
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