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Optimistic Projections

By publishing overly-optimistic projections, your company could be at risk for internal financial problems, misleading investors, miscalculating inventory and staff, and more. As we reach the halfway point in the year,  it’s time to revisit whether your company has realistic or optimistic projections.  Are your sales projections still on target?  Now is a good time to review your projections and adjust them if need be for the third and fourth quarter.

Optimistic Projections

Recently, a client met with one of our consultants. When the consultant began preparing their sales projections using our Sales Genie Tool, the client started complaining:

Our CEO, Ryan is too optimistic. He comes from a sales background, so he consistently over-projects sales whenever I, the CFO, ask for them. I don’t want to deal with sales!  I’m not the salesperson.  But our bank is frustrated that we’re not meeting our sales.  I can’t trust Ryan to make smart sales projections goals anymore. 

Sound familiar?

Having overly-optimistic projections is like waving a loaded gun… bad things will happen.  Stakeholders in your company rely on these projections and it’s important not to mislead them.

Why are CEOs and salespeople so optimistic?

Sales-minded people often set “stretch” goals…  an appropriate way to move a company forward, but it can shoot you in the foot.  Basing projections upon stretch goals can create problems when getting financing and allocating resources.  Your banker will wonder why you fell so short of your target and your inventory manager will be scratching their head wondering why there’s excess inventory.  In short, what starts in sales can lead to issues in operations and finance down the road.

The “Bullwhip Effect”

Bullwhip_effectThe Bullwhip Effect is a term coined by Stanford University to refer to supply chain changes. The same theory can be applied to sales projections.

A financial leader who doesn’t want to (or doesn’t know how to) project sales typically trusts that the sales team is projecting correctly forgetting that they are prone to cockeyed optimism when it comes to their performance.  The financial leader then submits projections based upon those forecasts to the bank and company management thinking that they’re completely accurate.

But in this example, sales overshoots the forecast by 15%. Operations has hired a few more people to manage the incoming sales and acquired more inventory. Sales sees the numbers coming in, still believing that those numbers are accurate; they give discounts freely and don’t collect in a timely manner. Accounting recognizes that the sales have happened and accounts receivable builds to an unmanageable amount.

All of a sudden, the financial leader is in a bind. Sales aren’t meeting the goal of a 15% increase; it’s more like 2% growth. Operations has tied up all the cash expecting increased sales.  Accounting is attempting to collect all of the sales as quickly as possible. The company is out of cash.

Things have spiraled out of control due to one small, well-meaning error.

How can CFOs or other financial leaders counter over-optimism?

Unfortunately, most sales projections fail due to a one-faceted (sales only) approach to forecasting.  When projecting revenue, it is imperative that you as the financial leader set guidelines and boundaries for your sales team to prevent optimistic projections from becoming gospel.

Here’s how you do it…

#1 Set Expectations

Schedule a meeting time for the financial leaders in your company to meet with your sales team. Set expectations as you move forward in creating sales projections.

These expectations could look like:

  • Review projections quarterly and adjust them if need be at that time
  • Have sales submit weekly reports to accounting to track trends
  • Schedule weekly or monthly meeting to discuss projections

#2 Create Projections Together

The biggest cause of optimistic projections is the accounting department asking sales to provide a number without any validation or input. Without any questions, those numbers are blindly put into the forecast.

There are two different types of sales numbers you should ask for from your sales team: the actual projection and the goal projection.

The goal projection, or a stretch goal, is often what causes these optimistic forecasts. Their purpose is to set a number high enough to motivate sales team to reach it. Oftentimes, it is set higher than is possible to reach. But this sometimes results in sales improving over the previous month or year.

For example, ABC Company’s sales were $20,000 in 2015. When forecasting sales, ABC set their goal projection to be $30,000 or a 33% increase in sales. Historically, there has only been a 5% increase over the previous year. The actual goal should have been a 5% increase as that has been the trend over the past 7 years.

In a meeting, explain the difference between the two types of goals. You need to actual sales goal for your projections, not the stretch goal.

If you’re still not sure how to accurately project your sales, click here to access your free Goldilocks Sales Method tool. This tool allows you to avoid underestimating or over-projecting sales.

#3 Communication

As we’ve said multiple times, there are three essential pillars within a business: accounting, operations, and sales.  Communication between these departments is critical to the success of your company.

Set expectations between accounting and sales that communication should be a priority. If your sales team indicates that they underestimated sales, then it is their responsibility to report that adjustment in sales.  Ask sales to track sales. They should have a weekly average of sales that they need to hit. If there is a trend that they are not meeting the projections, then it’s time to adjust.

Make communication an absolute priority. There is no shame in not meeting projections;  the trick is to adjust expectations going forward.

Conclusion

By proving that you as the financial leader or CFO can add value to a company through setting realistic and accurate sales projections, you’ll be better equipped to set yourself up for success.

For more ways to add value to a company, download the Goldilocks Sales Method to start projecting accurately and building credibility through your sales forecast.

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Why Prepare a Budget?

Do you need to take an umbrella to work today?

Without a trusty weather app or friendly meteorologist, it would be difficult to know the answer. Fortunately, you probably have one of these tools to help you make an informed decision.

The CFO/Controller is the meteorologist for the business.  It’s your job to help the company decide when, and if, you’ll need an umbrella.  How do you do this? Prepare a budget.

prepare a budgetWhat is a budget?

A budget is an estimate of income and expenses within a given amount of time. It contains economic goals, boundaries, and limits on expenditures of the organization.

Why Prepare a Budget?

So, why prepare a budget? By creating a budget, you’ll be able to hold the company accountable for its expenditures, reduce costs, and prepare for a worst case scenario. It serves as a measurement tool that can visually illustrate if you have enough cash to operate or to grow.

The steps in the budgeting process are:

  • Prepare the budget
  • Negotiate and agree on the budget
  • Monitor the budget

Prepare a Budget

First, you as the financial leader must choose what type of budgeting method you want to use. There are two main types of budgets: zero-based budgets and traditional budgets. While zero-based budgeting allows you to re-examine all of your costs, traditional budgeting is more user-friendly.

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Typically, prepare the annual budgets before the fiscal year begins. This window of preparation helps facilitate execution.  Early decision-making will provide boundaries within which the company must abide. Oftentimes, if you don’t prepare budget ahead of time and create it on the spot, then arguments and internal issues begin to arise. You can avoid disputes when executing a budget by preparing early.

During preparation, it’s important to focus on fiscal targets. Fiscal targets are are goals for specific financial categories. These could include profit, debt payback schedule, operating expenses, projected borrowing requirements, etc. By laying out these goals, you’ll be better equipped to prepare a budget that will allow negotiating and finalizing of the budget to go smoothly.

Optimistic Budgets

prepare a budget

As a reminder, an overoptimistic budget can result in late payments and disorderliness in regards to keeping in compliance with the bank. There are several ways you could be overoptimistic in your budget, the major one being you are not projecting your sales correctly. If you’re a couple cents off, it’s okay.  A budget should be seen as a “set of guidelines, not rules, based on the best forecasts at the time but always open to amendment as circumstances warrant” (Accounting at Your Fingertips, p. 332).

To reduce the chances of creating an overoptimistic budget, it’s important to go back to the basics. By focusing on the economics of your business, you’ll not only create a realistic budget, but you’ll be better able to project future growth.

(NOTE: Want an easy tool to analyze your company’s economics? Download the Know Your Economics Worksheet to make sure you’re pricing for profit!)

Negotiate and Agree on the Budget

As with most things in business, negotiation comes into play.  The purpose of negotiation is to allocate resources according to your targets and policies with everyone’s best interest in mind.  However, fiscal policies should provide the framework for budget formulation. Make sure that you consider your company’s economics when structuring the budget.

During this negotiation process, it is vital for you as the financial leader to maintain the meeting as a negotiation rather than let the meeting turn into a bargaining session. Bargaining results in a win-lose situation where the goal is to get as many of your points on paper over another person or department. It may drive the process, but it is not effective. Often, the outcome of bargaining is inefficient resource allocation.

By comparison, negotiation is all about a group of people working towards one goal. Part of this goal should be to comply with fiscal policies and targets.

Monitor the Budget

So much time and hard work goes into creating a budget, yet so many companies fail to utilize the budget. The purpose of a budget is to measure operational efficiency and performance issues.

The efforts of budgeting should be focused on improving revenue forecasting or projecting. A budget is useless unless utilized in a dynamic manner. While budgeting provides the short-term execution plan, forecasting allows you to take historical data to measure the reality of success in executing your budget. You’ll be better able to allocate resources to the right departments.

(Check out the 5 tools that you might not be using but should be implementing along side your budget.)

When you link the budget and the forecast, you’ll be more equipped to monitor the budget.  Contrast this with a static budget that is often useless after the first month. It all starts by knowing your unit economics and then assessing your economics to judge whether they are working for your company.

To ensure that your budget is built to achieve your business goals, make sure to start with the basics. Find out more about how you could utilize your unit economics to add more value to your organization by clicking the link below.

prepare a budget, Why Prepare a Budget

Strategic CFO Lab Member Extra

Access your Strategic Pricing Model Execution Plan in SCFO Lab. The step-by-step plan to set your prices to maximize profits.

Click here to access your Execution Plan. Not a Lab Member?

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prepare a budget, Why Prepare a Budget

There are many methods you can use to improve productivity in your company. Click here to download a PDF of 10 Ways a CFO Can Improve Productivity.

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