Good Forecasts Make Good Planning – December 2014

This topic concerns budgeting.

The budget is central to the company’s overall growth plan and acts as an essential management tool. In turn, the forecast is the key element of the budget. Consequently, good forecasting of expected revenues, expenses and cash needs keeps the company one step ahead of the many forces that affect demand and costs.

A good forecast enables management to frame their expectations for the year at all times. However, management must avoid reliance on plans finalized at the beginning of the year that are not updated to reflect the reality of events as they unfold. Accordingly, management must utilize the forecast as a working document throughout the year. One way to encourage this focus is to employ rolling forecasts whereby months or quarters are dropped and added to keep a constant 12 month projection.

The forecast provides management with a sense of the risks and opportunities the company faces and what can be done about them. Before constructing the forecast, management must determine which decisions they will make based on the forecasts. These decisions relate to every aspect of the business such as pricing decisions, cash needs and uses, hiring needs, and funding expansion.

Typically, the forecasting process starts with the CFO getting input from key personnel in operations, marketing, payroll, and other important parts of the business. That said, the CFO must avoid the temptation to drill down too far into the data. Such detail may add precision, but not necessarily accuracy. For instance, understanding the drivers of major markets and branches is valuable; spending a lot of time understanding the same drivers of individual products may add knowledge, but not value.

Once devised, the forecast is constantly used to understand how these drivers affect the business. This effort encourages a forward looking focus while not dwelling on the past. Such focus allows management to think about how to offset any negatives encountered by the company and how to further exploit the positives.

Now that the framework and benefits for using a forecast have been described, we suggest some questions for management should address to optimize the forecast and budget. These are:

• What factors influence your business and to what degree are they controllable.
• To which industry or industries do you sell.
• What types of customers do you have.
• What influences sales.
• What drives profits.
• Which variables that influence the factors above really matter.

Determining these answers is critical. Equally important is excluding extraneous details that clog the forecasting process. Such details dilute variables that really matter and moves the focus from what really drives the business. For example, inclement weather is probably not relevant for a law firm, but is very important for a trucking firm.

The budget should be central to the company’s growth plan and act as an essential management tool. A good forecast is critical to an effective budget. The forecast should enable managers to understand how the business drivers affect actual outcomes. This effort is enhanced by updating the forecast to reflect the coming twelve months. While the forecasts should reflect changing reality, management must avoid being distracted by extraneous details unrelated to the answers to key questions management must ask itself.

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