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Spreadsheets
Since the invention of the spreadsheet, people have been using them to create financial forecasts and projections. The spreadsheet automates much of the "what if" questions which arise in any financial environment. A simple example would be - "What if I could collect my accounts receivable a few days faster on average? What would my cash flow look like if I could accomplish this?".
While a spreadsheet can be extremely useful for certain tasks, they may create misleading information for other tasks. One such task are financial projections or financial forecasts.
Spreadsheets inherently use fixed numbers and formulas for calculations. On a micro level this may be adequate to produce realistic results. However, the further out you forecast and the more complex the situation you are trying to model, the more inaccurate your results will be. In a forecasting environment, probability theory plays an important role. For example, what is the probability of earning 20% higher revenues while maintaining employee costs at a fixed level. Spreadsheets cannot handle probability or statistical calculations very well. While software products do exist that can play this role, the cost and training to use the software is prohibitive for most small businesses.
The small business owner is left to consider the assumptions used for financial forecasts and projections and model these assumptions into the spreadsheet. It is critical that the assumptions have validity and it is critical that the spreadsheet emulates the assumptions accurately. The danger is that misplaced optimism will cloud proper judgement. For example, modelling a 20% growth in revenues when a more realistic amount is only 10%. There is a small probability that 20% is achievable, but there is a greater probability that 10% will be achieved. It is tempting, especially if the business owner is presenting the forecasts to a lending institution for more financing, to use the more optimistic (but less likely) assumptions.
Chartered Accountants are trained to consider the validity of assumptions and advise the small business owner on how to improve forecasts and projections. Contact Keith Anderson CA at (780) 447-5830 if you have further questions, concerns, or the need for advice.
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