Budgeting & Forecasting

The difference between a budget and a forecast:

• A budget is a detailed financial plan for the businesses financial year
• A forecast is the expected future financial performance based on today’s knowledge

MAP runs for our clients:

1. A budget, which is fixed for the year ahead
2. A live financial forecast based on converted revenues
3. A live financial forecast based on expected revenues (quoted and expected to be converted)

Although the budget is fixed as a default, it may be subject to periodic reviews through the financial year, typically (but not necessarily) at the end of each quarter. If when you assess the business at the end of a quarter, it is clear that the budget for the rest of the year is now overly optimistic or pessimistic, you may conclude that the budget should be revisited and updated.

The budget will be built using information from several sources:

1. Historical information – looking at what has happened in the past as a guide to predicting the future
2. Known future information – converted revenues and costs that have been committed
3. Expected future information – ranging from early-stage conversations to proposals and general judgement and insight

Although a forecast can consider all 3 of these sources of information to predict future performance, it is usually more based on exact pieces of information (2 & 3) and not patterns gleaned from the past (1).

However, a business might be interested to project based on the trends so far, mid-way through a year.

As you can see, a lot of information, intuition and judgement goes into budgeting & forecasting and we, therefore, need tools to enable us to build and adapt our financial models accordingly. Without this level of sophistication, the model becomes too “forced”, it misses vital information and therefore ceases to be useful and ultimately the business gets drawn back into spreadsheets.

The Problem with Spreadsheets

Spreadsheets are widely adopted as one of the most common IT applications. They are learned from a young age and their use is ubiquitous in business, none more so that in financial modelling. Most people have at least a general understanding of how to read and use a spreadsheet, and they are therefore often adopted to avoid having to learn and implement new technology.

However, there are dangers with using spreadsheets and these old habits lead to the same failing occurring time and time again.

1. Lacks integration

Spreadsheets are not generally integrated with your accounting software. That means they are not capable of pulling the historical transactions into your model to allow you to shape and predict the future. If it is possible, it is often a challenge to present the information in a clear and usable way, or it is not live. This leads to a lot of time being wasted trying to find the right information and copy it into your spreadsheets in a clear and useful way, and keep it up to date.

2. Custom nature

As is often the case, the strength of something can quickly become it’s weakness. The custom nature of spreadsheets is second to none when it comes to being able to manipulate a model to do what you want it to. This is not so useful when trying to get a universal understanding of how a model works. 

Everyone will build a model differently and there is therefore a lot of time wasted in picking up someone else’s model and trying to understand hope it has been built and how it is to be used and edited. As well as lost time, it also increases the risk of error since the person picking up the model is not as familiar with it as the person who built it, and therefore might misunderstand or miss something altogether. Even the person who built it in the first place may struggle to follow their own logic if they have not been “in it” for a while.

3. Risk of error

These risks can be negated slightly by building templates in spreadsheets and training the team on a unified approach. However, it only takes one update from a member of staff that falls through the cracks and suddenly the model becomes confusing at best and at worse, risks errors. 88% of spreadsheets contain errors.

Spreadsheets are, generally, prone to errors in that they are relying on lots of people with different experiences, skills and familiarity with the model in question. Even if you’ve built your template, you will undoubtedly come across the client that believes there is a better way and you are under pressure to oblige because you and they both know that you can, because it’s just a spreadsheet, so it’s easy…

Ready-Built Financial Modelling Software

With all the risks that come with using spreadsheets, the obvious alternative is to consider Financial Modelling Software. This software has been built to do exactly what you have previously been trying to DIY in spreadsheets. Countless amounts of thinking, energy and money have been poured into these applications by professionals who are experienced in the very skill of financial modelling. They have done the hard work for you and it is ready to use.

A good financial modelling software application should boast these key benefits:

1. A simple UI – A user interface that makes it easy to build your financial model seamlessly
2. Sophistication – All the flexibility you need to be able to run the calculations that you would be able to run in spreadsheets. Otherwise, guess what you will be heading back to!
3. Beautiful reporting – Once you’ve had your head down in the detail for a few hours, you need to be able to lift up and produce a report that is meaningful for the business
4. Integrated with your accounting software – Combatting one of the frustrations of spreadsheets, you should have the ability to work from your existing accounting data
5. Scenario Planning – We don’t live in a perfect world where there is only one realistic view of where things could go. You therefore need to be able to plan several different scenarios for how the story of your business will unfold
6. Forecasts both profit/loss and cash – The profit and loss statement shows the commercial truth of your business and cash flow shows whether you have the runway to be successful. Both are important and both need to be modelled.
7. Understand the detail – Finances are lagging in nature, even future looking forecasts. They are the results of lots of decisions and activities. You don’t just “get more revenue”, you get more leads or more conversions or a higher average order value. A really good financial modelling tool will enable you to work with these “drivers” to zone in on individual campaigns and project the impact on the wider business.

When your business has this level of financial modelling available, you are able to have a deep understanding of the activities of your business and how they interact with each other. You are able to set goals, make informed decisions and flex your plan as reality unfolds.

Keeping on top of all the moving parts in your finances is a real challenge. Trying to do it across multiple files and platforms then adding in the complexity of multiple scenarios, it’s clear why this is such a challenging and time consuming function for the business.

We have long been in pursuit of a platform that delivers on these 7 key areas and we think it has finally arrived.

Meet Fathom Forecasting

We have been users of Fathom for some time now at MAP. Our clients have experienced the power of the reporting functionality through the Management Accounts that we produce at month or quarter end. We have always enjoyed working with the platform due to it’s user interface, the integration with Xero and the general capabilities of it’s reporting.

If we could have chosen which company we would most like to break the 3 way forecasting problem, it would be Fathom. Implementation has been significantly eased by the fact that we are already using the platform for reporting and we can now compare our clients actual financial performance against the budgets and forecasts that we model in the new Forecasting module.

Despite our delight for Fathom building just the feature we wanted, right where we wanted it, we still had to put their Forecasting module to test. We had to make sure that it was going to stand up to the real world challenges of dynamic forecasting in businesses with varying requirements.

We have therefore assessed Fathom Forecasting against the 7 requirements that we listed above for Financial Modelling software:

1. A simple UI – The Forecasting functionality is a joy to work with. It is clean, quick and easy to follow.
2. Sophistication – This was a big holding of breath, since it’s what all the other platforms have failed to deliver and what ultimately leads accountants back to trusted old spreadsheets. We are so pleased with Fathom’s use of Drivers & Formulas to build non-financial metrics and leading indicators and combine them with the chart of accounts and typed values to build the financial model from ground up.
3. Beautiful reporting – This was an easy one. Since we had already been using Fathom for Management Accounts reporting, we knew that the reports were already beautifully designed and our clients love them.
4. Integrated with your accounting software – Again, we have enjoyed the seamless integration between Xero and Fathom for many years. This is now supporting the forecasting process by pulling all of the historical financial data into one place
5. Scenario Planning – Scenario PLanning has been done many times before in forecasting apps, but it was a relief to see that Fathom have done it the right way in that it enables scenarios to be built from, and updated by, the baseline forecast. This means that any adjustment to the baseline only needs to be made once, and it will automatically be fed into the additional scenarios created.
6. Forecasts both profit/loss and cash – Fathom uses the indirect method of forecasting, where cash flow forecasts are derived from the P&L and Balance Sheet activities. It asks the user to enter the “Cash Timing” profile of all revenue and purchase accounts to current month, following month +1, +2, etc. This is usually the most relevant approach for our clients as we model a profitable budget first and then assess the cash position that results. Where detailed daily cash flow forecasting is required, we use Float to predict cash flow based on specific transaction dates.
7. Understand the detail – In order to build a meaningful budget, a number of areas of the business needs to be scrutinised. That could be analysing the expected ROI on a specific marketing campaign, the fees expected to be generated by making a new hire, the repayments and interest associated with a loan received, and more. Fathom has created it’s ”Microforecasts” to achieve this and the results on the overall financial statement of the business are updated automatically.

We are excited to have the opportunity to take business planning and forecasting a level deeper through Fathom’s capabilities and we are looking for clients to partner with us on gaining this increased level of maturity for their agency.

If you are ready to start seriously driving your agency forward through this deep planning and visibility, please get in touch with [email protected].