The importance of forecasting for SMEs

The importance of forecasting for SMEs

By Dominic Buch, managing partner and co-founder, Caple

The importance of forecasting for SMEs

Growing small businesses need access to finance and forecasts – and as the most trusted advisor to these firms, accountants are essential to helping them secure funding.

With the recent proliferation of funding options and the changes in the asset base of many growing firms, funders have developed different requirements on which they will make a lending decision.

Rather than just relying on a single set of accounts, funders often need detailed forecasts that project the future performance of the business. As a consequence, it has never been more important for accountants to help their SME clients meet these new challenges.

What was the issue?

Historically, firms might have typically funded their business by accessing a loan from their bank which would have been secured against a physical asset, such as property or stock.

If a company with finance raised against physical assets went out of business, a bank could recover its money by selling those assets. Lending decisions would therefore be centred around the value of the assets and a set of annual accounts, rather than the performance of the business.

The very nature of this process is backwards-looking. Often, it does not account for the future growth potential of the business, and it is only useful for those businesses that have physical assets to use as security. Both of these factors limit the finance available to firms and put a brake on growth.

How has lending changed?

Today, there are many more options for business owners wanting to fund growth. These range from the high street banks and asset-based lenders to equity funders and fully-unsecured lenders, such as Caple.

As a result, it is not always necessary to provide physical assets as security. In this situation, where there are no physical assets to fall back on, lenders need to be more certain on the future performance of the business.

They will move from focusing on an historic set of accounts to the forward-looking cash flow forecasts.

The importance of accurate forecasts

So, firms asking a lender to fund growth and buy into the strategy of the business must support their case with clear, high-quality forecasts. In other words, SMEs and their accountants should view their business and its forecasts as a lender would.

They must question their growth assumptions, look beyond the next 12 months and focus on key metrics such as converting profits to cash. As the forecasts are only as good as the assumptions, business owners need to be able to explain them, and must be ready for questions on sales, costs, and how the lender’s repayment fits into the overall picture.

Often these challenges, coupled with a bit of tension, can help create higher quality and more accurate forecasts. These are far more useful than presenting an overly optimistic view of the future.

Quality forecasts can also help with the sale or purchase of a business. For instance, in a management buy-out, forecasts are vital as the buyer needs to understand what they are purchasing and their expected return.

The role for accountants

Accountants can play a central role in helping their SME clients access the right funding by identifying suitable lenders and developing the high-quality forecasts and business plans that are central to raising funds based on future cash flows. These include the profit and loss accounts, cash flow forecasts and a range of other documents.

As part of this process, accountants will be able to advise their client on what works best for them. For instance, an accountant will work through how much debt a business can service and advise accordingly, and can also be vital in helping the SME to articulate their funding need and businesses strategy.

Rick Payne, Corporate Finance Director at Bennett Brooks, explains: “Experience of working with a wide variety of businesses means we can quickly develop forecast models that are readily flexed on the key assumptions.

“As each business is different the key metrics can vary. But once established we are able to challenge clients on the main sensitivities of the model assumptions. If necessary, we can either look at ways to mitigate the issues that arise or set out the focus for the management team.”

In a competitive marketplace, lenders need to be able to buy into a business’s value proposition alongside the quality of the financial information. High-quality strategic advisors are important to help develop such insight.

“By challenging assumptions we enable SME owner managers to better deliver these forecasts and improve funding success rates,” Payne continued. “We also know what funders need to see. Clear and succinct information presented in the format funders are seeking helps speed up the decision-making process.”

Growing businesses are important for growth of the economy, and accountants are crucial in helping them secure the funding they need to grow.

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