Why Preparing Three-Way Forecasts is So Vital

By Tony Monisse

Learn why it is important to forecast the profit & loss, cashflow and balance sheet.

As I see it, a budget is merely a forecast prepared at a point in time.  This point in time is usually tied to the end of the financial year and the business’ planning cycle.

In contrast, a forecast is frequently updated based on the changes in the operating environment e.g. winning a new contract, losing a key customer or a change in the staffing situation.

The goal for any business should be to make the budgeting process the same as the forecasting process, so that minimum resources are committed to an outcome that can quickly become out of date.

In the current economic environment and with the uncertainty around the impact of COVID-19, it is important for the business to prepare regular forecasts.

The forecasting process should be owned by the key stakeholders, not just the finance team.  For example, the sales forecast should be prepared and owned by the sales team and the production team should determine the production levels and the operating margins.

The forecasting process should always be tied to a time period necessary to make decisions.  In my experience, businesses should prepare two types of forecasts:

  • 13 week rolling forecast, which is used to manage short term cashflow, which is especially important in the current environment;
  • Rolling four-quarterly forecasts, which are used to measure performance against targets, including the budget and to take corrective action.

It is important to prepare three-way forecasts.  Early in my career, I learnt to never look at a profit and cashflow forecast without a balance sheet forecast.  The balance sheet forecast is proof that the cashflow forecast makes sense.

The key steps to preparing a three-way forecast are described below.



  1. Forecast sales based on past KPI activity or a projected sales pipeline. I often hear businesses say they cannot forecast because their revenue is too unpredictable.  In these cases, I think a better outcome is to forecast sales required to achieve an acceptable profit level.
  2. Review the cost assumptions, including breaking down costs between variable costs (which are tied to the sales forecasts) and fixed costs (or overheads) that do not change.
  3. Review if fixed costs will need to change based on changes in capacity required to deliver on the sales forecast e.g., new premises or additional head office staff.
  4. Forecast available government subsidies



  1. Review the assumptions for working capital. In particular, in what period will trade debts be collected? (will this be affected by the current environment?), how much inventory will you need to hold and when will you pay your trade creditors?
  2. Determine distributions to owners, including wages, drawings and dividends.
  3. Review the timing of tax payments.
  4. Allow for the purchase and divestment of plant and equipment required to achieve the sales forecasts.
  5. Review the finance requirements for new plant and equipment as well as existing finance commitments.



  1. Review if the forecast balance sheet makes sense, including whether the working capital looks right, whether the amount of debt relative to the business assets is reasonable and whether the shareholder loan accounts look correct.

I have found if a business uses the above process to update its forecast periodically, it is better able to anticipate changes in the operating environment, make better decisions and take action to protect its cashflow and achieve its targets.

If you would like to discuss this process further, please do not hesitate to contact me or our office on (08) 6212 7200.