What is a 3-way financial forecast and when do I need one?

Stepping up to the balance sheet and beyond

We have a saying that captures when it’s time to move beyond just your P&L and how much cash you have in the bank:

“If you don’t understand (from your P&L) where your cash is going, the answer is on your balance sheet.”

If you are trying to predict future cash needs, especially as a startup or when juggling cash in growth periods, you’ll quickly realise the other elements that affect cash but are not well reflected in your P&L. These include the following.

Compliance-based payments

While you’re probably aware of most of these, ask any startup or SME owner about the ‘gotcha’ impact of these each quarter… so you want to make sure you’ve got these covered, in advance.

• Superannuation (payable quarterly)
• If you’re big enough, you also have the joy of paying state-based payroll taxes
• Net GST that you collect from customers, less GST you pay to suppliers. Net GST is typically payable (or receivable) as part of your quarterly BAS
• PAYG (the taxes you withhold from your employees) is also payable in quarterly or monthly activity statements
• If you’re making a profit, you need to plan for annual tax payments or quarterly PAYG instalments
• If you’re accessing the R&D Tax Incentive, you’ll be forecasting to receive a refund from the ATO

Accounts receivable and accounts payable

Accounts receivable is the money you receive from customers or other people who pay you. Accounts payable is the money you pay suppliers and creditors. Together, accounts receivable and accounts payable drive the working capital needs of your business.

As a simple example, if you send out invoices to customers and there are delays in receiving their payment, you can go broke much quicker than expected, despite being otherwise successful or profitable in theory. 

Operationally, you need an active and tight escalation process to collect any money you’re owed. In your financial forecasts, you need to allow for the difference between revenue you have invoiced for and revenue you have received. You might hear this called ‘debtor days’. 

When it comes to accounts payable, there can still be delays in paying suppliers even though we have more automatic payment options than ever before – you need to allow for this too. 

Loans

If you have any form of interest-bearing loans you need to allow for regular cash payments to cover the loan interest and principal. Loans can include startup loans, shareholder loans, bank loans and even ATO payment plans. 

Other items

• Revenue recognition – many of our clients receive pre-payments, such as annual contracts (sometimes referred to as ‘bookings’).  While this is good from a cash perspective, it is not correct accounting-wise to refer to it as simply, revenue. Strictly speaking, you need to recognise one-twelfth of the cash received as revenue over 12 months. This is not just accountant speak. Investors and banks will expect to see this in any forecasts 
• Prepayments and deposits – this is kind of the reverse of revenue recognition. It’s where you’re pre-paying suppliers and landlords for subscriptions, insurance, rent, etc.
• Buying cash assets – this involves a monthly depreciation in your P&L. This tends to come up when you’re growing fast

It’s true, we’ve spent more time on this balance sheet section than on the P&L. This is because accounting for the timing of things on the balance sheet in a forecast can quickly become complicated with lots of things to keep track of. As it becomes more complicated, it is better handled in a 3-way forecast.