Focus on Forecasting & the COVID-19 Pandemic

Focus on Forecasting & the COVID-19 Pandemic

Focus on Forecasting & the COVID-19 Pandemic

As one would imagine, the owners of shares in any company – including companies that are partially or completely owned by an Employee Stock Ownership Plan (“ESOP”) – are typically very interested in the performance of the business and its ability to create future value. This interest has been heightened as a result of the COVID-19 pandemic and its disruption to the economy, supply chains, global population and businesses throughout the world.

Although some business owners may feel the process of preparing a forecast of future performance is akin to reading a crystal ball, forecasting remains an important part of business planning since investors, including ESOP trustees, typically look to projected cash flows to determine the company’s current value.

Whether or not the company has a history of forecasting, now is still a good time to start. When initially preparing a forecast, the company’s management team should start with the basics. For example, depending on the type of business, management may want to review factors such as the organization’s weekly, monthly or annual sales goals; whether regional sales goals are being met; if the sales team has minimum goals which need to be achieved in order for commission to be awarded; whether customer agreements require maintaining minimum inventory levels; the impact of supplier contracts – or the lack thereof – on the business; and whether there are industry benchmarks the company is trying to achieve.

Other planning tools include “top-down” and “bottom-up” forecasting. Generally speaking, top-down forecasts tend to be broad-based or “big picture” reviews. They start with general information about the overall market in which the company operates and then work down to determine the company’s potential revenue based on market share. Conversely, “bottom-up” forecasting focuses on specifics within an organization and tends to have a sales- or production-based focus. In a “bottom-up” forecast, individual departments create their own outlooks which are then built into an overall company forecast. Oftentimes, companies use a hybrid of these approaches when planning, as the two methods can serve as a system of checks and balances in order to help determine whether the company’s forecast is realistic and achievable based not only on the marketplace but also on feedback from key staff members such as sales leaders and/or the production team at a manufacturing firm.

Notably, when preparing a forecast that will be used as part of a valuation for ESOP purposes, it is also important to consider the U.S. Department of Labor’s (“DOL”) perspective. Projections, the validity of the projection assumptions and their impact on a company’s valuation have been a central focus of the DOL’s enforcement efforts. Although these reviews by the DOL were conducted before the COVID-19 pandemic, it seems likely similar questions will continue to be asked.

Pitfalls to Avoid When Forecasting

In our view, the DOL considers it important for both the valuation firm and the ESOP trustee to conduct a critical analysis of the management team’s projections before incorporating them into the fair market value analysis. Key issues the DOL has suggested should be analyzed relate to the consistency of performance comparison, achievability of the forecast and the overall sensitivity of assumptions. While these are good questions to ask any time a forecast is being prepared – whether for an internal corporate purpose, planning for an acquisition or in the context of an ESOP – the DOL has looked to the rigor with which this analysis is being conducted by the valuation firm and the ESOP trustee as well as the documentation that is available to support the forecast.

In addition, shareholders, as well as valuation firms and ESOP trustees, should look to see whether the management team’s forecast has addressed the unique challenges of the current environment. When a company experiences a sharp decline in revenue, such as during the pandemic, the forecast should make rational assumptions about how the company will work through the recovery. Since the pandemic is still ongoing as of this writing, the path to recovery remains somewhat unclear. Management teams must do their best to consider a wide range of factors when preparing forecasts in the current environment. The forecast should project out to a time period which the management team anticipates will be a period of “normal” growth or when margins will stabilize at a targeted level. In the scenario of the current pandemic, depending on the specific company under review, this may be three to five years away, or more.

In any case, there are several issues to consider when preparing a forecast for recovery from the COVID-19 pandemic, including the following:

While this outline includes numerous factors to consider when preparing a pandemic and post-pandemic forecast, the specific factors which should be included in a forecast for your company may vary depending on the specific market and industry in which that company participates. Remember, any forecast includes inherent risk, and this is especially true in the uncertain times in which we are operating. In any case, it is important to keep in mind that all investors are interested in future performance, and therefore, when preparing a post-pandemic forecast, the management team should be cognizant of any new information which may impact the company’s outlook.

Hillary Hughes is a Director at Prairie Capital Advisors, Inc. She can be contacted at 319.366.3045 or by email:

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