Below is the transcript of our Drop the Mike Webinar: The Importance of Forecasting for Government Contractors, led by our VP of Client Engagement and lead guitarist, Mike Kalnasy.
To gain a complete understanding of the dialogue with visuals, we recommend watching the webinar. Watch the full webinar here.
In today’s webinar, we’re going to be discussing forecasting for government contractors. Forecasting in a lot of ways is similar to being a musician. You’re piecing together things so that you can get a whole picture. You Know Stevie Ray Vaughan, Jimi Hendrix, and a lot of great blues players pieced together blues scales just to write their compositions.
You also have other guitarists such as Eddie Van Halen, who used certain techniques such as tapping to write in their compositions.
Those are just fragments, just pieces of something, but those things are building blocks to something bigger and better. That’s what you have to think about when you’re looking at forecasting as a government contractor. We’re building something bigger and better, looking to the future, conveying a theme and message, and reaching those goals that we’re trying to attain.
So in today’s webinar, we want to focus on key metrics, why forecasting is so important to government contractors, and how CAVU can help you reach those goals.
Keys to Financial Forecasting
1. Baseline Plan
So as we begin today’s webinar, much like we discussed just a moment ago, the components to a forecast, much like fragments or pieces of a song or a piece of music, are going to build up the overall picture and the message that you’re trying to convey or want to convey.
You know we look at the pillars of the forecast as key metrics such as your revenue, your profit margin, both as a function of percentage and dollars, the cash position of the company, and the rate variance. These are all things that we work with our clients to make sure that they are tracking within their forecast.
Let’s take a step back and talk about forecasting and budgeting and what makes sense to do. As we look here at our dashboard summary tab, we are actually comparing our baseline forecast for 2021 to a plan or a baseline plan for the year. You may start the year with a baseline plan that you’ve locked down to say if everything goes according to plan, this is what we think is going to happen, and this is how it’s going to meet expectations, but things change. You may hire somebody. You may win contract awards. You may have some additional expenses that come in. Those things are what we work with clients to factor into a living and breathing forecast so that they are actually able to compare that to their baseline plan and then see how they’re tracking.
You know, as we look at this current demo setup, this company is actually projected to bring in more revenue than their baseline plan, but their profit margin and some of the other metrics that we’re tracking are down. So that’s something we would dive into with our clients to say, okay, what is causing that?
It is very important to set that baseline plan because it’s really a good measuring stick. But a true forecast, where you are taking into account the current and future assumptions for the year to predict the changes and the ebbs and flows, is critical to have a very sound set of financial metrics that you can make informed decisions on.
2. Revenue & Profit
We’re able to dive into revenue and profit and look at this both on a period-over-period basis and then from a cumulative perspective. Here on this tab, we’re actually comparing a 2021 forecast against a baseline plan and then also 2020. In this case, it says the forecast, but this actually means actuals in this assumption here.
We’re able to look at last year’s data in comparison to what we budgeted for this year, and then also against how we’re actually performing and projected to perform with the forecast so that we can make informed decisions.
You know it’s important to look at your historical data because it does help you analyze things, but then also the forecast is really going to be a very key factor in looking at against your baseline budget in particular because when you see ebbs and flows, that makes you question what happened, and with a lot of our clients, we dive into that.
If those things happen, we dive into and say, okay, what did happen? Why? Is there something that we need to take into account? Do we need to be more conservative with certain planning aspects of the forecast? You know those are things that you want to look at, and looking at things in this manner where we’re comparing the forecast to the baseline plan to the prior year; we’re able to get almost like a 3D view of the financials, so to speak.
Looking at them both from a period and a cumulative basis helps us paint a picture, and then if something seems like it could be off track both either in a good direction or a negative direction, we want to investigate that and make sure that our assumptions are correct and that we’re telling the right story.
You know information is incredibly invaluable but having that at your fingertips and being able to react is what’s critical. We work with our clients monthly on this, and a lot of them tell me, you know, ‘I love having this because I’m able to make these decisions like I need to.’ That’s really one of the critical pieces of forecasting and why you should be doing it.
Here on this tab, not only are we looking at your revenue and profit margins, but also we can look at the culmination of your expenses and how you’re spending. Are you spending more on your unallowables than you were in the prior year, or according to how you had originally done your baseline budget? Are your indirect costs higher? Or are you still spending more on direct costs or about what you had budgeted?
We look at this here; you can see that this company’s unallowable expenses actually decreased, but then their direct costs increased. Maybe that was intended. Maybe there were additional contract wins or additional work. Those are the factors that we consider when we talk to our clients to make sure that we’re looking at all pieces of puzzles to make informed decisions for the future.
3. Cash Flow
Cash flow is a critical metric to government contractors or any company for that matter. You know, when we talk about the pillars of a government contractor’s financial forecasting, a lot of it involves your cash, profitability, and rate variance. Companies who are cash basis taxpayers are constantly trying to balance their cash balance at the end of the year for taxable income purposes in addition to what their rate variance is. Then also their overall profit dollars to make sure that they’re meeting things such as any line of credit covenants, etc.
So, we look here at cash; we’re again able to give almost that 3D view looking at the prior year, the baseline plan, and then the forecast for the year. As you can see here in this plan, we may have forecasted for cash to be higher, but for some reason, it’s lower. Is it a function of the receivables going up? Your receivable balance is climbing higher here. Is it possible that you’re getting paid a little bit slower than you anticipated? We take those things into account, we review with our clients, and you should be reviewing too. You don’t want surprises. Cash flow is critical for companies to be able to react and conduct business.
When you look at payables, you need to know when you will have to cut checks or pay expenses. Are you going to need more cash or any external financing to meet payroll, things of that nature? So, it’s important to be tracking this as well as your line of credit balances.
If you have an external line of credit facilities, things that are going to help you with your operations, you do need to factor that in. Your banking institution is likely going to want to see some sort of reporting that lets them know how your cash balance is doing and how your receivables are doing because that isn’t entirely dependent upon that line of credit. Again these are things that we work with our clients on, on a monthly basis, and we make sure that we’re talking about these things so that there isn’t a big surprise if the cash flow suddenly drops or if there’s a big influx of cash. We can easily tell the story and understand why it happened.
4. Income Statement
We have a dashboard here looking at a comparative income statement. This is really where we get into the nuts and bolts of what happened during the month and throughout the year compared to our baseline plan. We look at it with clients looking at much of the top line statistics such as your revenue, direct costs, your indirects, and obviously your net income from a current month perspective against your baseline plan and then a year-to-date perspective against your year-to-date plan.
We want to know what happened during the month and why. Revenue exceeded expectations. Did we expect that to happen? However, net income didn’t meet expectations. So, we want to drill down into why revenue increased, but our net profitability decreased. We’re looking at these metrics across the board with clients to tell the story and understand so that we can make informed decisions. Here this company had significant overspending and direct costs for the current month compared to their plan. Was that expected? Those are the questions we constantly are asking ourselves, and we should be as we’re looking at our financials.
Again, we also can look at our margins, gross operating, and net profit from a forecast perspective, a baseline plan, and then see if it’s meeting expectations. Your gross profit is actually a very key metric that you should be looking at. Am I capturing the best value for my direct costs out of what I’m billing from a revenue perspective?
If your gross margin isn’t high enough, you may not have enough captured to be able to support your indirect spending, and that’s critical. It is a key indicator of value, so we always advise our clients to look at that percentage, and you want to get yourself in a range where you truly are capturing good value.
I hear many times from companies that they won a big award, and it’s adding all this top-line revenue. Well, what is it doing to your profitability? Are you counting that also to the bottom line? Companies can add revenue, but it doesn’t mean that they’re adding value.
So, this is one of the key metrics we like to hone in on and focus on with clients to make sure that again they’re capturing the best possible return on their direct costs. If you don’t do that on the front end, you’re not going to be able to support the indirect spending and then, in turn, bring in the profitability you need as a company.
Again, we’re able to also look multi-year at revenue and profit so you can see how the company has been performing year over year. Finally, as we’ve talked about before, taxable income for cash-basis taxpayers. Our model takes into account several assumptions, such as receivable days, spend plans, etc., so that we can project out what your potential estimated taxable income from the company will be for cash-basis taxpayers.
You know, with our clients, we don’t want them to have a surprise when they get to the end of the year, and their tax bill comes due. We constantly measure this metric month over month, and as we get closer to year-end, working with their tax team to ensure that we’re hitting targets and executing the overall tax strategy plan.
Nobody ever wants to get that surprise when the tax bill comes due, and that number’s really large, and they weren’t expecting it. So again, this is one of the key metrics that we do focus on as part of our model. Again, it’s something you should be focusing on as part of your forecasting so that you’re adequately prepared as you head into your end when you want to execute a strategy to meet these targets for your taxes.
5. Indirect Rates
Again, one of the other pillars, if you will, for government contractors is indirect rates. Indirect rates capture the return on your spending for pools such as fringe overhead and G&A, and it particularly impacts people with cost-plus-fixed-fee contracts.
Your government customer doesn’t want to be surprised if you have to get additional funds on a contract to cover a rate variance, and they certainly don’t want you to have to give money back. So, it’s critical to be able to manage this with your cash flow and taxable income in the account as well.
You know, with this, we have clients that may have T&M or fixed-price contracts primarily. So, you may say rate variance isn’t as critical, well, not so fast. These numbers effectively, if you are primarily T&M and FFP, are coming in and out of profit. But keep in mind, you may bid on something that’s cost-plus-fixed-fee at some point in the future. You may need to keep a pulse on this.
This is also indicative of things if, for example, you want to go out and you want to look at bidding on another opportunity. How are your indirect rates tracking compared to how you originally budgeted them? We can see that there is an underrun which is great, so then can we bid at lower rates to be more competitive and still cover our costs. These are questions that we constantly ask ourselves, and you should be asking yourself as part of a forecast.
We go over this with clients monthly to look at this and make sure that we are using the best possible projection for rates, and if we are bidding on new opportunities that we’re doing it with, then you know the best rates possible that are most representative of what we are actually performing at.
I’ve seen companies over the years get in trouble with not using good rate data. They’ll go out and bid on something kind of blindly without having a good handle on their indirect rates. So while if you are doing T&M and FFP work, you may not think this is as critical, it definitely is.
6. Project Data
We also have the ability to bring in project data and again analyze it. If you’re in QuickBooks and need to bring project data in to apply your indirect rates, we can do that so that you can get your project reporting through your indirect costs to truly gauge what the net margin is on each other projects and how it’s performing. That is critical for contractors because if you aren’t performing well, and let’s say you aren’t capturing the best gross margin, you can drill down into that project data and really take a look at it and see is there a particular project that’s weighing you down so to speak, and can you address it. Again, these are critical things you want to look at with both your forecasting and your financial reporting to make informed decisions.
We’re also able to categorize the revenue and the profit of projects so that you can see where you know one project may be the top performer in revenue is it all also the top performer in terms of profit. Sometimes it’s not always the case, so you’re also looking at your projects with a function of value as well.
We’ve talked about a lot of things here today that are important to forecasting, and it’s essential that we take a measured approach to this again, putting the pieces together to paint a critical picture. You know it’s important to look at these metrics, look at a baseline budget and compare your actuals to it. Then also look at how things are changing. Look ahead three months, look ahead six months, and factor those things into a living and breathing forecast so that you can make informed decisions. This is one of the most powerful tools for a business owner to make those strategic decisions to help guide their company into the future.
Encore – Q&A
Q: What happens if I have a new contract come in and it brings in 15 positions? Can we simulate or look at what that does to impact my metrics?
A: The answer is yes, absolutely. We can put those new hires into our forecast model and look at how that impacts your indirect rate variance, your cash flow needs for payroll, should you not get paid immediately by your client, and also what that’s going to do to your cash basis taxable income.
So yes, those are things that we love to do what-if scenario planning. That’s exactly what we are here to help you do.
Stay tuned for our next webinar!