Financial forecasting: how to predict future business growth
Like many entrepreneurs, Simon and Michelle Chapple, who set up search marketing company Total SEO in 2005, were mostly interested in gaining new clients. The company provides search engine optimisation (SEO) services to businesses, helping them climb up the Google rankings. Its model offers a free evaluation to begin with and then paid-for services if the client requires more. Initially they began logging client enquires and leads on a Google spreadsheet and amended it as progress was made. However, as their business grew this process became untenable. “We were victims of our own success,” says Simon Chapple. “Google docs was great when you had 10 or 20 leads but not when that became 100 or 200.”
Every time the directors wanted to know how much business was in the pipeline, what current sales were, or how much it was owed, they had to trawl through some unwieldy spreadsheets to find out. It got to the point where this was Michelle’s main job. “It made us less efficient and it filtered through the whole organisation. One of the directors was doing this when she could’ve been helping customers or working with staff,” Chapple says.
In April last year they instituted an accountancy software programme, which combined with a CRM database. Chapple says having easily accessible data has made an enormous difference to the business and it has increased its client base by over 60% since then. “I know month-on-month what we have been doing. I predicted this year’s growth to within a few thousand pounds and therefore I’ve been able to calculate how many staff and how much office space I’ll need,” says Chapple.
Chapple also says his business model makes it possible to predict with some accuracy how much new business the company will be able to bring in at any time. “Our conversion rate from sign-ups is consistently about 10%, so we can predict how many sales we are making by the number of people who sign up for a free appraisal,” he says.
Chapple’s early problems are common among growing businesses and new entrepreneurs. When starting out most are concerned about bringing in the sales and proving their business idea can work. Day-to-day concerns and client relationships tend to trump administrative duties and as the business takes off entrepreneurs suddenly find themselves with a data backlog and a lack of tools to deal with it.
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Nick Brown is a serial entrepreneur and founder of Corporate Exit, which advises small businesses on how to sell their businesses. He says making accurate predictions based on historical cashflow is a major part of the due diligence process when a business is sold, but also it is good practice in any case as it aids planning. He says business owners need to take themselves out of the day-to-day and focus on the bigger picture.
“A lot of small business owners don’t spend much time away from the day-to-day running of a business, which is understandable as they don’t employ many people,” he says. But if they take a step back and focus on how the business is performing it is really useful.”
Like most experienced entrepreneurs, Brown says understanding cashflow is crucial. “Cashflow is reality. It doesn’t matter how much profit you have on paper, until it’s in the bank it’s not real. Many sales guys get over-excited when they ‘bring the business in’ but until the customer has paid it’s not a done deal. You need to make sure the invoice is out there and getting paid, rather than getting too excited about the forecast.”
Brown advises entrepreneurs to forecast low and not to get too carried away with predictions, particularly when they come from the sales team. “There’s no point in presenting a fanciful spreadsheet, it’s got to mirror the last three years and if the reality is better than the forecast then that looks good to all your partners, financiers and suitors.”
However, Brown also says that predictions and projections are only useful to a point and entrepreneurs should base them on the best information they can use. “You can make some projections because you will know probably whether a client is about to start spending and is about to make an order. But forecasting can be a bit pie in the sky which is why I always recommend to people to forecast low. People can go belly-up on you and if your forecast doesn’t include any bad debts it wouldn’t be realistic,” he says.
When change floods in
But some entrepreneurs aren’t impressed with such old school forecasts and budgeting and say the digital age is about to disrupt the financial and accountancy sectors. Margaret Manning is the founder digital agency Reading Room, which she set up in 1996. Since then, it has grown into a £18m turnover business with 260 staff. A former accountant herself, Manning is firmly of the belief that the digital world is too fast-moving for old-fashioned forms of financial management and projections. However, she has held views counter to those of her colleagues since the 1990s. “I have always been of the belief that company forecasting was a short term thing – how many small businesses go out of business in the first year?” she says. “My focus has always been on cash. I didn’t do a profit and loss account for the first five years – all I did was cashflow forecasts.”
Today she is using a new form of forecasting and budgeting known as agile accounting or beyond budgeting. It’s a practice which a considerable number of high profile and successful firms, including Lego, Volvo and AstraZeneca, are interested in, and have joined the Beyond Budgeting Institute. For Manning, it represents a shift from old-fashioned budgets based on annual results and instead creates a system using key metrics which empower managers to make decisions faster. “Businesses need to be agile and flexible,” says Manning. “In order to do this they need to understand what their core financial drivers are – there aren’t many – and then build their key performance indicators around them.”
Manning tells her core drivers are people; turnover per head and budget per head. She says focusing on these figures’ means she can free up her team to hire and invest as necessary. “You are saying to people you can adjust as necessary. You can flex your budgets and we will be able to see it reflected in greater turnover,” says Manning. “There’s no point creating five year plans anymore, that’s ludicrous. Digital is moving so fast it’s like a tsunami sweeping everything away. The financial sector is the one last great bastion which is yet to be fully hit, but it will be.”