In our previous post, we discussed the different metrics the founders of tech services need to monitor to guard against down-quarters. Getting a handle on most of these metrics requires disciplined data collection. There is one exception, the targets. These targets reflect the founders' aspirations. These aspirational targets are balanced by grounded actuals. Forecasts bridge the gap between the two. These three types of numbers and their interplay forms the backbone of a sound financial plan. This article delves into the significance of each and how they intersect in the broader context of strategic finance.
Actuals, the verifiable financial data from previous periods, serve as the bedrock of any strategic finance activity. Good bookkeeping and accounting will provide timely access to the actuals. The actuals give you an understanding of past performance, a reality check on your old targets and forecasts, and form the basis for your new targets.
Targets are the financial goals that a company aims to achieve within a specific timeframe. They represent the desired state of the business's future financial performance. Targets are realistic aspirations of the business. The targets are how an organization writes its future. What bets to take, what resources to expend, where to focus our efforts. These critical business decisions serve the targets.
Forecasts are projections of a company's future financial performance based on current and historical data. Even though they also represent the future, they are distinct from targets because they reflect the expectations from the known reality. We create forecasts from the ground up to determine both best and worst-case projections for the future and the viability of our targets.
Strategic finance requires constant reconciliation of actuals, targets, and forecasts. This reconciliation process involves aligning past performance (actuals) with future expectations (forecasts) and desired outcomes (targets).
When actuals differ significantly from targets, the business needs to reassess its strategies. For instance, if actual revenue falls short of the target, it may require modifications to the sales strategy or cost structure.
Similarly, when actuals deviate from forecasts, it prompts a refinement of forecasting models. For example, if the actual gross margin is consistently higher than forecasted, it might indicate that the forecasting model underestimates the gross margin and needs adjustment.
The most interesting relationship is between targets and forecasts. It can be confusing as both are predictions for the future, but both are necessary. The targets tell you where you want to go. The forecasts tell you where you are headed. As you go further in the future, the two will start to diverge. And you need to invest today to make the targets a reality.
Proper strategic planning requires a keen eye on the targets, actuals, and forecasts. Founders of tech services startups need to understand how to use these three types of numbers to create consistent growth. If you are a founder starting to build the organizational muscle for financial strategy and planning, we hope you found this article helpful. One piece of advice we have is to treat it like a journey. You will improve your forecasts, better understand how to build strategies and plans to hit your targets, and provide better data on actuals to take timely action. It is okay to start with bad numbers because it is most important to start today.