FORECASTING & BUDGETING

Transcription

1 FORECASTING & BUDGETING W I T H E X C E L S S O L V E R

2 WHAT IS SOLVER? Solver is an add-in that comes pre-built into Microsoft Excel. Simply put, it allows you to set an objective value which is subject to a variety of constraints. Solver will automatically change the values of the cells which you specify in order to get to your objective value while satisfying all constraints. It is a very powerful tool for financial modelers and anyone doing analysis where you have a number of intertwined pieces of data. For example, a financial modeler may want to maximize net income (objective value) by changing departmental expenses and cost of sales, subject to those expenses being within a certain percentage range of sales (constraints). 2

3 A BIT OF BACKGROUND In my previous work, forecasting and budgeting was an important aspect of my job. As any financial analyst will tell you, creating a budget isn t exactly difficult. It s just numbers in squares, joked a colleague of mine. Having it all make sense, however, was a whole different story. When I first started, the process was terrible. Short meetings with departmental executives conflicted with the objectives of Corporate, and it all culminated once a month in an all-night scramble to put it all together, try to satisfy everyone, and deal with the questions later. There was no cohesiveness, just trying to get to a magic number, such as target net income growth, by any means necessary. Something had to change. Determined to improve the process, I built in a series of checks into my forecasting models which would alert me to anything unusual. I made sure that commissions were related to sales, offsite storage costs were related to inventory levels, margins were realistic and salaries were consistent with headcount projections. It wasn t long before I had quite an extensive list of statistics. The process was improving but still, it was very labor intensive. I still had to enter the values and see the impact on the bottom line. That is where Solver comes in. Solver allowed me to integrate the statistics I was already calculating directly into my forecasting model. Now, instead of having to manually change dozens of sales and expense lines, I could simply set the constraints to the targets set by our management team and have it produce the results for me. An important shift then occurred. Now, instead of Management spending their time questioning whether the forecast made sense, they were spending their time determining whether or not it was achievable. This is a small example of how finance can really make a difference in driving business strategy and excellence. 3

4 HOW PRACTICAL IS SOLVER? M a n a g e m e n t E x p e c t a t i o n s Top-level managers focus on the big picture. They do not spend their time in the trenches, obsessing over every small detail on an income statement. Instead, they have big picture ideas for how their business should be run, and someone like a financial analyst can help them get there. Creating a detailed forecasting and budgeting tool which you know will produce a result in line with their directives is a great starting point for creating a plan forward. Afterwards, it is common to make some adjustments in order to create a goal which the entire team can get behind. C o m p l e m e n t a r y I t e m s Income statements are a prime candidate for Solver, as so many items on it are related to one another. Gross margin percentages are usually within a certain range. Commissions expenses are usually budgeted as a percentage of sales. Offsite storage costs may increase after a particular inventory value is hit. These are all examples of constraints you can set in Solver. While it will require a significant upfront investment of your time, Solver can help streamline your budgeting and forecasting process and allow your team to focus on what really matters to your business. 4

5 BUDGETING A S I M P L E E X A M P L E In the attached spreadsheet, you will find a basic income statement that we will use to calculate a target net income. This is the objective cell. If you click through the values in the Budget column, you will see that some have formulas relating to sales. For example, Cost of Sales for Products is expressed as a percentage of Product Sales. The same goes for Wages & Fringe Benefits, which are expressed as a percentage of Total Sales. Other items which are more fixed in nature, such as Rent & Occupancy Charges, have a fixed value instead. 5

6 BUDGETING (2) A S I M P L E E X A M P L E In Columns E and F, we set our constraints, expressed as Minimum and Maximum values. The Solver column (G) is the cells which we are going to tell Solver to adjust to meet our objective cell. The next step is to set up our objective cells and constraints by clicking on Solver in the Data tab of Excel. A dialog box titled Solver Parameters will open up. Follow the instructions on the following page to set things up. 6

7 SOLVER STEPS STEP Set Objective Cell INSTRUCTIONS In this example, the objective cell is going to be net income, cell E24. This cell is expressed as a percentage growth over last year (C24/D24-1). We will set this cell to equal 10%, or 0.1. Identify Variable Cells To Change Set Your Constraints Set Calculate Determine Best Case Adjust We now have to identify which cells we want Solver to adjust for us. In this example, we would like it to adjust all sales, cost of sales, and expense items in Column G (G4:G5,G9:G10,G16:G21) Solver will need to know how the variable cells it is changing are constrained. In this example, we have inputted Minimum and Maximum columns to make this easier to identify and to change if desired. For example, Product Sales (G4) has to be greater than the Minimum Value (E4) and less than the Maximum Value (F4). Input these separately as G4 > = E4 and G4 < = F4. Repeat this step for all variable cells identified above. When complete, just click on the Solve button. Solver will either report that it has found a solution in which all the constraints are satisfied, or it could not find a feasible solution, indicating that your objective cell is not realistic and your constraints need to be modified. It is important to realize the limitations of your model. As an analyst presenting to management, you should calculate a best case scenario to start in other words, what is net income growth if sales and margins are maximized while expenses are minimized. To do this, set the Objective cell to Max. Having this number in mind will help set expectations. Take a look at what Solver has calculated for you. Does something seem off? If so, you may want to adjust the Minimum s and Maximum s of that particular cell and re-calculate a new set of results. 7

8 REMEMBER A financial model is only as good as its inputs. It is still susceptible to the Garbage In, Garbage Out phenomenon. However, if done carefully, it can be used to streamline your forecasting and budgeting process.

9 THANK YOU W W W. G E O F F R E Y L E A R M O N T H. C O M G E O F F R E Y L E A R M O N T H + 1 ( ) G e o f f r e g e o f f r e y l e a r m o n t h. c o m