Balance Sheet Forecasting Guide: How to Plan Your Key Line Items

The balance sheet is responsible for answering one critical question in your business—what is the cash impact of our operations?

That’s why balance sheet forecasting is critical to any business leader’s understanding of their cash position.

But many businesses wait too long to establish a high standard of financial rigor around their balance sheet. The sooner you get in the habit of granular balance sheet forecasting, the sooner you’ll be able to understand the true cash impact of what you’re building into your financial model.

However, spreadsheet-based financial models don’t allow you to easily link income statement assumptions to cash impact on the balance sheet. Shifting to financial modeling software can help you maximize the accuracy of your balance sheet forecasting and give you insight into the cash impact of all your operational decisions.

What Is a Balance Sheet Forecast?

A balance sheet forecast is an estimation of your company’s assets, liabilities, and equity in the near future. A balance sheet forecast is part of a three statement financial model (along with your income statement forecast and cash flow forecast) that projects material changes in your company’s cash balance. It’s important to keep the balance sheet forecast in mind as you build your financial model. Every assumption you make in your model will impact the balance sheet, and all of those impacts boil down to one vital question: What is the cash impact, and when?

This process of building financial assumptions can be time consuming. But assuming you have the right level of data integrity, you’ll have the foundation to understand the three main components of your balance sheet:

• Assets.The beginning and ending balances for key categories such as accounts receivable (which are managed and tracked through accounts receivable KPIs), inventory (if applicable), cash and cash equivalents, and prepaid assets (including their amortization).
• Liabilities. Balances for accounts payable and other liabilities like deferred revenue, taxes, and long-term debt/loans payable.
• Equity. Common and preferred stock balances and other shareholder capital accounts and retained earnings.

These main line items give you visibility into your net working capital. And some basic financial modeling overviews will tell you to project the line items by:

• Forecasting your income statement except for depreciation and interest expenses
• Planning the balance sheet aside from retained earnings
• Using balance sheet insights to finish depreciation, interest, and taxes on the income statement

This “financial modeling 101” overview is important to understand. But the best finance and accounting teams go so much deeper with their balance sheet forecasts.

How to Forecast a Balance Sheet

The deeper you try to get with balance sheet forecasting, the harder it becomes to build and maintain in spreadsheets. There are too many other tasks on your plate to keep up with the tedious, manual process of making sure all the financial data in a granular rolling forecast ties out.

But if you want to get the kind of precision in cash planning that enables you to make better, more strategic decisions, forecasting at the account level is a must.

Follow these four steps to go a step beyond basic balance sheet projections.

1. Roll Forward Balances and Choose Your Forecast Methods

Start your forecast by rolling forward account balances from the previous period. Because the balance sheet is cumulative, rolling balances forward allows you to see how individual accounts change over time and impact your cash position.

The asset account you use to purchase employee computers is a good example of this process. You can use last period’s balance as a starting point for your forecast. And you can assume that you’ll have to purchase a new laptop (~$2,000) for every new hire you bring on.

To project that asset account accurately, you should forecast on a per-head basis. You can see an example of this process in the image below.

If your headcount plans tie into your balance sheet, you’ll be able to see a balance sheet projection that automatically increases according to hiring expectations and capital expenditures. Then, the next step would be to forecast the depreciation and amortization on a per month basis from the balances you create with incremental headcount hires.

You can also use a manual forecast method to project one-off asset purchases. For example, you might know that you’ll need to purchase new furniture as your employees come back to the office. You can create a new line item in your balance sheet forecast with a $50k purchase in the furniture account during the month you expect to make the purchase.

Rolling forward your balances each period and adding new line items for account-level balance sheet projections gives you and your team greater visibility into the company’s future cash position.

2. Select Which Accounts to Forecast from Net Zero

It’s important to be able to roll balances forward in your model. But that approach to forecasting doesn’t make sense for every account on your balance sheet. In some cases, you’ll want to forecast from net zero.

Forecasting from net zero is the better approach when you know from a flux analysis that there have historically been significant fluctuations in an account. Accounts payable (AP) is the best example.

Because accounts payable can vary greatly from period to period, starting your forecast with no balance makes sense. Then, you can use financial ratios to project accounts payable as a percentage of other accounts, like in the image below.

Here, you can see that we’re driving the accounts payable forecast by a three-month average of key income statement accounts that you historically pay via the AP process (professional services, rent, and sales and marketing). Applying that percentage forward means that as your operating expenses increase across those accounts, the overall AP account will increase accordingly.

Approaching “lumpy” accounts like AP in this way gives you a more consistent view of your cash balance and helps you plan with more precision.

3. Project Your Net Working Capital Accounts

One of the most important reasons to maintain a balance sheet forecast is to get a strong handle on your net working capital—a measure of your short-term financial health that shows the difference between current assets and current liabilities.

Accounts receivable and accounts payable are the primary inputs for net working capital calculations. But deferred revenue and delays in collections make accurate working capital projections difficult. You could use a trailing 12-month average to forecast AR and AP components of working capital—it’s just not the most accurate approach.

Ideally, you can project net working capital by automatically tying top-line revenue, billing, and collections plans to your balance sheet forecast. Mosaic automates the ending balances for these accounts and shows changes in cash across your forecast period.

There are situations where you want some flexibility in deferred revenue planning. But as long as the underlying data automatically connects, your planning process will be much smoother.

4. Create Events to Highlight Major Impacts to Cash

Your balance sheet forecast has to account for major one-off events that will significantly impact cash positioning (either positively or negatively).

The simplest example is if you’re planning a new funding round. You need to add a line item to your balance sheet forecast that includes the money you expect to raise and when you expect to raise it. In the image below, you can see the process for adding a fundraising event to the Cash & Cash Equivalents account on the balance sheet.

You can also use events to highlight major cash outlays you know are coming up. Maybe you’re planning on signing a new lease for office space. You know the cost will be $30k per month. But you also have to account for the $250k deposit on your balance sheet. You expect to get that money back, but it’s still a significant impact on cash balance that your balance sheet forecast has to provide visibility into.

Four Ways Mosaic Makes Granular Balance Sheet Projections Easier

None of the components of a granular balance sheet forecast explained above are groundbreaking. These are things that finance and accounting leaders want to do—they just don’t typically have the time to do it consistently. And because private companies don’t technically need to forecast at this level, most leaders will focus on other strategic tasks.

This is why moving from spreadsheets to financial modeling software can be so valuable. The right tool automates the time-consuming aspects of granular financial modeling, freeing you up to do the kind of strategic planning outlined here.

There are four main features of Mosaic’s Balance Sheet Planner that make forecasting on an account level much easier than it is with spreadsheets.

1. Flexible forecast methods. Add multiple forecast methods (e.g. per month, per head) to individual accounts and line items to forecast precisely.
2. Automated roll forwards. One-click ability to toggle whether or not your account balances roll forward, so your model properly reflects your business.
3. Customizable account-level assumptions. Edit the names of new account-level forecasts and assumptions so anyone who looks at the model can easily understand the projections.
4. One-off event builder. Add new events that will impact your cash balance, including details like the date of the event, its duration, the specific accounts the event will affect, and how much money to add to the forecast.

Each of these features contributes to a more strategic planning process. Instead of simply projecting the high-level line items on your balance sheet, you can dig deeper and provide more visibility into how strategic decisions will impact your company’s financial health.

Build More Dynamic Financial Models to Improve Decision-Making

Point-in-time financial projections are supposed to help you understand how decisions today will impact the future of your business. But without a dynamic way to build those models and keep them updated, you’ll remain stuck in reactive reporting cycles.

We continue to add new enhancements to our financial modeling product, including giving users more control over things like balance sheet forecasts.

If you want to learn more about how some of these features work and what they could do for your planning processes, schedule a personalized demo today.