However, not all forecast models are created equal, and there are certainly a number of traps you can fall into if you’re not careful. Here are some of them:
- Making the model too complicated: A financial forecast model that is overly complicated can be difficult to understand and use. There’s nothing worse than spotting a mistake in a forecast model then running around in circles for hours before discovering the cause. It's important to keep the model as simple as possible, focusing on the key variables that are most important to the business.
- Using unrealistic assumptions: A financial forecast model is only as good as the assumptions that underpin it. If the assumptions are unrealistic or not based on accurate data, the model will not be reliable. Not only will potential investors and stakeholders struggle to get on board, the model will quickly become redundant and won’t have long term utility. It's essential to use realistic assumptions based on comparable historical data and industry benchmarks.
- Investing in a model, then forgetting about it: A financial forecast model is not a one-time exercise. It needs to be updated regularly to reflect changes in the business environment, such as changes in market conditions, customer behaviour, and economic trends. Failing to update the model regularly can lead to poor decision-making.
- Neglecting flexibility: There’s real value in a financial forecast model that can demonstrate different scenarios. Businesses should be able to sensitise the model by running different scenarios to see how it performs under different circumstances. When designing the model, it’s imperative to keep this in mind and avoid “hard-coding” where possible, such that changes to the core assumptions flow through seamlessly.
- Ignoring the balance sheet and cash flow: A profit and loss is only part of the story. For a financial forecast to be viable, it needs a fully integrated profit and loss, cash flow and balance sheet. Avoid having balance sheet items that don’t fluctuate over the forecast period, try to model these as realistically as you can. A fully integrated model gives the reader a much clearer picture of the business’ plans.
Creating a financial forecast model can be tough, but it’s an important step for any business. By navigating the traps outlined here, businesses can create a reliable and accurate financial forecast model that helps them make better decisions and plan for the future.
The next step
If you need support with your financial forecast model, please get in touch with Dan Thomas on d.thomas@uhy-manchester.com, or your usual UHY adviser.
