Canada: Using Budgets and Forecasts as a Tool for Value Creation

Last Updated: September 17 2015
Practice Guide by Duff & Phelps

Many business owners and executives are reluctant to prepare budgets and forecasts for their company on the premise that the future is just too difficult to predict. The one thing that is true about forecasts is that they are always wrong. Despite that reality, where properly done, budgets and forecasts can be a useful tool for shareholder value creation.

Budgets vs. Forecasts

Before proceeding further, we should distinguish between budgets and forecasts. A budget normally refers to the financial projections for a near term time frame, such as the following fiscal year. It represents the targets and objectives for the company, and often serves as a basis for setting management performance objectives. As such, budgets are (or should be) established prior to the commencement of a fiscal year and not modified once approved by senior management or the board of directors.

Forecasts normally refer to a longer-term projection, such as a 5-year period. However, an even lengthier time horizon may be appropriate where the industry in which the company operates tends to experience longer term cycles.

Forecasts normally flow from a company’s long term strategic plan. Forecasts are also prepared in the context of predicting a company’s financial results for its current fiscal year, and are updated based on year-to-date actual results and recent industry and economic developments. The current year forecast is compared to budgeted results to determine whether the company likely will fall short of, achieve, or exceed its targets.

Budgets and forecasts normally are prepared on the basis of annual operating results. However, it is important that monthly and quarterly budgets and forecasts also be prepared (at least for the near term) in order to assess the impact of seasonality within a business and to identify times during the year where additional financing may be required or capacity limitations may be reached.

Decision Making and Shareholder Value

By taking the time and effort necessary to prepare a rigorous budget and forecast, business owners and executives can make more informed decisions. This is because the budgeting and forecasting process forces business owners and executives to ask themselves tough questions, and to be better prepared to deal with different scenarios. For example, if the forecast calls for revenue growth or 10% per year, at what point will the company need to increase capacity, in terms of expanded facilities, additional headcount and other infrastructure requirements? These costs should be factored into the forecast, and management should begin planning for the initiatives that will have to be undertaken to facilitate growth at an early stage.

One of the most significant benefits of proper forecasting is that it helps business owners and executives to assess whether the company’s growth initiatives will lead to incremental shareholder value. Business owners and executives often look at measures such as revenues and EBITDA (earnings before interest, taxes, depreciation and amortization) to assess how their company is doing. However, growth in revenues and EBITDA does not necessarily translate into greater shareholder value. This is because shareholder value is based on a collective assessment of three inter-related factors, as illustrated in Exhibit 1:

Exhibit 1: The Determinants of Shareholder Value

  • cash flow, and specifically discretionary cash flow, which goes beyond EBITDA and takes into account capital expenditure requirements, working capital requirements and income taxes;
  • the risk profile of a business, which takes into account the likelihood that forecast cash flows will be achieved; and
  • invested capital, which refers to the ability of an organization to use debt in lieu of equity in order to generate cash flows, as well as managing its asset base.

Therefore, a proper forecast will help business owners and executives to assess whether the investments that are made in order to generate future cash flows will ultimately serve to increase shareholder value.

Characteristics of Meaningful Budgets and Forecasts

It takes time and effort to prepare a budget and forecast that will be meaningful for decision-making purposes. In this regard, properly-prepared budgets and forecasts should have the characteristics set out in Exhibit 2:

Exhibit 2
Characteristics of Meaningful Budgets and Forecasts

Detailed Revenues and Expenses

High-level forecasts, which are restricted to gross revenues, total expenses and profit levels, are of little use. While they may reflect the long-term objectives of the organization, significantly more detail is required in order to form the basis for executive decision-making.

For example, revenues should be forecast by customer and by product / service offering. This can be a significant undertaking and difficult to predict. However, it forces business owners and managers to address important issues, such as:

  • what proportion of the company’s revenues will come from recurring customers;
  • do any customers represent a significant amount of the company’s revenues (e.g. more than 10%); and
  • to what extent will new product and service offerings have to be introduced in order to achieve revenue targets?

These factors have a significant impact on a company’s risk profile, which is one of the key determinants of shareholder value.

Similarly, expenses should be sufficiently detailed in order to distinguish between variable costs, fixed costs and step costs, for the purpose of sensitivity analysis (discussed below).

Supportable and Internally Consistent Assumptions

Budgets and forecasts are based on assumptions, which inherently are subjective. However, the assumptions adopted in the budget and forecast should be reasonable and supportable. This means that, where possible and practical, the assumptions should be supported by third party evidence, such as independently published industry growth rates.

As a general rule, the assumptions adopted in budgets and forecasts tend to be more optimistic than not. A meaningful budget or forecast should adopt assumptions that weigh both positive and negative factors.

In any event, regardless of the assumptions that are adopted, it is critical that they be applied in an internally consistent manner. For example, if revenues are projected to grow by 10% in the next year, then the forecast must reflect all of the operating expenses, capital expenditures and working capital required to generate and support that rate of growth. Internal inconsistency is one of the most common deficiencies in financial forecasts.

Sensitivity Analysis

Given that the inputs to a budget or forecast are subjective, it is important that the budgeting or forecasting model allow for sensitivity analysis. Sensitivity analysis is an important tool for decision making. It forces business owners and executives to consider the key “value-drivers” within their business, and the variability of economic returns (e.g. profits and cash flows) to changes in assumptions. As such, sensitivity analysis can be a useful tool for risk assessment and risk mitigation.

As part of the sensitivity analysis exercise, business owners and executives should consider the “degree of operating leverage” within their business. Degree of operating leverage measures the percentage change in earnings before interest expense and income taxes (EBIT) for a given change in revenues. For example, if a 5% decline in revenues results in a 5% decline in EBIT, the degree of operating leverage is 1:1, which suggests a relatively low level of operating risk (at the expense of reduced upside potential). Conversely, if the degree of operating leverage within a company is 5:1, then a 5% change in revenues will result in a 25% change in EBIT. If this level of volatility (i.e. risk) is considered too great, then management may want to adopt a more variable-based expense structure (e.g. paying commissions rather than fixed salaries to sales personnel).

Complete Set of Financial Statements

Too often, budgets and forecasts only contain an income statement. In order to be an effective tool for both decision making and shareholder value measurement, a full set of financial statements is required (i.e. income statement, balance sheet and cash flow statement). Cash flow statements will identify the capital expenditure and working capital requirements in order to generate growth, and whether additional financing will be required to do so. The balance sheet will help in assessing the total capital requirements within the organization, and provide the foundation for metrics such as borrowing capacity, asset utilization and return on capital.

Financial and Non-Financial Performance Indicators

The budgeting and forecasting model should incorporate both financial and non-financial performance indicators. Financial indicators are measures such as profit margins (e.g. net income as a percentage of revenues), financial leverage (e.g. total debt to equity) and asset utilization (e.g. revenues divided by total assets). The various financial indicators should ultimately culminate in a return on equity, which is an important measure of shareholder value.

The problem with financial indicators is that they tend to measure end results and symptoms of underlying issues. Therefore, it is important to consider non-financial indicators as well. Non-financial indicators include such measures as revenues per employee, capacity utilization and gross profit per unit. Trends in non-financial measures tend to be leading indicators of potential issues and opportunities. In particular, non-financial indicators can help management in assessing possible capacity constraints (in terms of employee availability, production capabilities and so on), which in turn can help in the company’s strategic planning process.

Other Benefits of an Established Budgeting and Forecasting Process

A credible and internally consistent forecast forms the basis for measuring shareholder value pursuant to the discounted cash flow valuation methodology, which in both theory and practice is the preferred basis for value determination. This can help business owners and executives to measure whether shareholder value is being created over time.

Another benefit of the budgeting and forecasting process is that it helps to communicate the concept of shareholder value among employees and middle-level managers, which may influence their decision making. Having management participate in the budgeting and forecasting process can also help in securing employee buy-in to the longer term goals of the organization.

Finally, business owners and executives who are considering a corporate divestiture at some point in the future will benefit from a well established budgeting and forecasting process. Creating a credible forecast will help in demonstrating value to a prospective buyer and in negotiating a better price and deal terms.

Initially, a considerable amount of time may be needed to prepare the financial model and consider all of the variables. However, the budgeting and forecasting process generally becomes easier over time, as business owners and executives begin to develop a mindset for the variables that need to be considered, and relatively minor modifications to the financial model are required.


Budgets and forecasts do not create value in and of themselves. Rather, properly prepared, a budget and forecast can be a powerful tool to help business owners and executives in their decision-making process, and to ensure that growth initiatives are likely to result in greater shareholder value.

In order to be meaningful, budgets and forecasts should be sufficiently detailed, backed by supportable and internally consistent assumptions, and with sensitivity analysis capabilities. Budgets and forecasts should also contain a complete set of financial statements as well as both financial and non-financial metrics. While the time and effort required to prepare meaningful budgets and forecasts should not be underestimated, the payoff can be well worth the investment.

This document is not intended to create an attorney-client relationship. You should not act or rely on any information in this document without first seeking legal advice. This material is intended for general information purposes only and does not constitute legal advice. If you have any specific questions on any legal matter, you should consult a professional legal services provider.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Contact the Author?
Click here to email the Author
In Association with
In Partnership with
Other Canada Advice Centres
Competition and Antitrust
Mergers and Acquisitions
Labour and Employment
More Advice Centers
Useful Resources
CBVs are experts in their field. The following articles and papers have been written by CBVs, several articles have been featured in various national publications.
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions