Forecasting for 2021 will be drastically different from any planning and projection work done in prior years.
In previous years, forecasting or planning for the coming year was often completed by looking at how history unfolded and applying new factors to the actual results, but the general operations of the company remained the same or with limited alternative factors applied.
However, in 2020, most companies had to completely reinvent themselves. Perhaps a new e-commerce distribution channel was created or strengthened, new customer bases were targeted, or products and service offerings were altered to significantly change margins or turnover rates. These pivots will require companies to remain flexible and dynamic going into 2021 by using both short-term and long-term models, applying probability estimates to a host of scenarios, ensuring that forecasts were easy to use and update to account for constant changes in expectations, and reviewing budget to actual at least quarterly to allow for less reactive and more proactive behavior.
What Should Be Considered?
In order to adapt 2020 results to 2021 forecasts, users must consider all of the aspects that may have contributed to 2020 being a different year. Cost pools are likely to have changed drastically with the elimination of discretionary costs such as travel, advertising, bonus or profit-share, and office expenses offset by the addition of personal protective equipment (PPE) supplies, office cleaning, and software or hardware investments to enable employees to successfully work remotely. Furthermore, there may have been one-time cash inflows, such as Payroll Protection Program (PPP) loan proceeds and other assistance grants, or reductions to cash outflows through deferral of payroll taxes, debt, or lease payments. Balancing the unusual cash flows and timing of expense levels will require additional consideration this year.
Who Are The Users Of The Forecasts?
Another nuance of 2021 forecasting is that there will likely be many more users interested in the company’s forecasts and therefore, the use of multiple scenario models will be helpful. A worst-case scenario may be used internally to manage decision making for capital expenditures, resumption of paused benefits, and cash flow management. A best-case scenario can be used for internal motivation, goal setting, and creative thinking. An expected scenario which blends these two will be used for multiple third parties such as investors, bankers, and accountants, as well as the owners.
How Will The Forecasts Be Used?
Investors will use these expected scenarios for planned or potential buy or sell decisions. Business owners will use the forecasts for tax planning which becomes increasingly important with the political landscape and potential changes to tax rates.
From a financial statement perspective, forecasts will be used to determine valuation allowances against excess inventory based on sales projections. Fifteen-month cash flow forecasts may also be required to support going concern issues for those companies that suffered a decline in 2020, with new requirements to show positive cash positions one year from the date of financial statement issuance. Further, management has a choice in accounting standard regarding PPP loan proceeds. Forgiveness income may be recognized as income in the year the covered expenses were incurred (i.e., 2020), or when forgiveness is awarded (likely 2021). Scenario modeling of bottom-line results and financial covenants is vital to ensure that the proceeds produce the best financial answer for businesses. Beyond a simple bottom line or EBITDA calculation, debt covenants projections should be incorporated into the forecasts in order to determine when the forgiveness income should be recorded, given that companies have a choice in accounting standards.
Regardless of 2020 results, the overall pulse of the lending industry is increasingly stringent. Banks will be looking at forecasts and cash flow projections now more than ever to help determine loan amount, both for new debt and renewals.
Forecasts are a vital tool to successfully running your business and making sound decisions. Despite all of the intricacies and challenges that may arise with 2021 forecasting, being prepared will pay off in dividends. There are a lot of factors to weigh and users to balance. It may seem overwhelming and a bit of a “what comes first” situation, but that is where leaning on your trusted business advisors can help you excel. At Citrin Cooperman, we have experience with various client situations and we can present questions or points for consideration, as well as help with forecast modeling and decision support.
Emily Richi is a partner at Citrin Cooperman. For more information visit https://www.citrincooperman.com/