Most of my clients have never prepared financial forecasts. This means I have to get the process started by presenting a preliminary one to educate them and give us a basis for discussion. On the other hand, some clients do prepare them, and I consider them in my analysis. This post compares and contrasts how I handle these two situations.
When I work for a client who does not forecast, I begin with the default assumptions in my financial model (discussed in other posts). This is a “things continue as is” forecast with extended historical growth, constant margins, and most assets and liabilities growing with revenue. I then blend in considerations from the economic and industry analyses. This first cut forecast does not (unless the client has mentioned them) get into things like fixed versus variable costs and major capital expenditures. The purpose of the first cut is only to be able to put something relatively simple in front of my client that helps them understand what assumptions are most important (sensitive) and how the numbers work. Once they get a feel for that, I can address the more sophisticated issues. This may take a few iterations, but the end result is a forecast that considers everything that I and the client believe to be important, provides good basis, and is plausible, supportable, and replicable.
When clients prepare their own forecasts, I usually find that they do a pretty good job with revenue and expenses, sometimes providing extensive detailed support. I will check these against my economic and industry outlooks to make sure we are on the same page. The challenge I usually run into is that clients forecast just income statements, not balance sheets. How can they project interest expense, pretax income, and net income? In this case, I put their revenue and expense projections into my model as a starting point and prepare a complete (income statements, balance sheets and cash flow statements) forecast for discussion with them. Again, we iterate some versions, but end up as above.
Regardless of whether the client provides a forecast, I am independent, since I have an objective, factual basis for each assumption: either I provided it and the client confirmed it or the client provided it and I confirmed its reasonability independently.