Understanding the basics of forecasting

Everyone who participated in developing the annual budget rightly feels a sense of accomplishment once the final budget is approved. Executives, department managers, and cost center owners, most of whom took substantial time away from their normal business to contribute, will likely celebrate by putting the budget out of mind and give their full attention back to their normal business. Yet for finance, the budget is their normal business, and one that involves convincing the contributors that it’s also their business for the remainder of the year. 

Expectations are firmly set once the annual budget is approved. Both the finance department and the wider company are now responsible for delivering on the approved budget, with a large proportion resting with finance. Think of the annual budget as a contract requiring results, but that also contains areas needing  renegotiation as conditions change to assure that deliverables can be fulfilled. Finance assumes the dual role of contract administrator and lead negotiator. 

To do both effectively, finance must assess the past and future simultaneously. At the beginning of each month, the finance team analyzes the prior month’s actual performance, and asks a set of very pointed questions:

• What happened last month? 
• Does it match the expectations made 30 days ago? 
• What varied?
• What caused the variances?  
• What are expectations for the next 30, 60, 90, and 180 days?  

Forecasting is the process of collecting and analyzing this data, then applying the results to provide the entire organization with as much clarity about the future as possible. In our experience working with customers, forecasting is one of the most reliable and effective strategic management tools available. It is also one of the easiest to neglect. 

Dealing with urgencies at the expense of what is important  

As businesses find themselves in the thick of the trading year, committing to delivering a regular, robust reforecast becomes a major challenge. Month-end close takes precedence. The related tasks of management reporting, cash flow analysis, and auditing are often poorly automated and use any remaining available time and resources. These competing demands result in the forecasting process being viewed as overly cumbersome, manual, and time-intensive, making it a low priority. Consequently, businesses usually forgo a regular reforecast. 

Yet without a regular forecasting process, the organization uses only a historical mindset without addressing what may happen in the future. Also, a backward-looking perspective solidifies the normal routine, where the finance team remains preoccupied with endless urgencies rather than proactively planning for how the company will avoid risks and execute on its strategy for growth.  

Forecasting is effective only when it happens before changes are made 

Many organizations conduct a reforecast only when an economic, political, or social shock disrupts business operations on a large scale. Some believe businesses should allocate their resources to executing on strategic plans, not spooking themselves about rare events.  

Yet an organization’s management should be called into serious question if it expends significant resources reacting to business shocks within its planning and predicting capabilities. A lack of a regular forecasting process instills a culture of reactive behaviors throughout all layers of management. Without an up-to-date forecast, the business operates without a navigation plan, drastically limiting its ability to identify and mitigate operational risks, establish effective cost containment strategies, and capture new market opportunities ahead of competitors.  

When management scrambles to react to an event   without a plan in place, it ends up throwing good money after bad. That’s one of the fastest ways to prompt an unpleasant one-way conversation from the same corporate governance board that only a few months ago enthusiastically approved the annual budget. 

Connected Planning helps businesses overcome obstacles to forecasting   

Companies already working in a Connected Planning environment find that they are able to produce regular, rolling, driver-based reforecasts. The benefits are significant.  

Regular reforecasts provide management teams with a shorter feedback loop to address business problems and capture opportunities, especially in key strategic management areas, including:

• Containing escalating costs to protect margins 
• Covering cash flow shortfalls 
• Launching new products 
• Entering new markets 
• Attracting external investment, resources, and talent 

In our experience, most companies aspire to move to a rolling forecast model, yet struggle with it due to several factors. A common one is the perception that forecasting is purely a Finance exercise, where it takes on a patrolling or punitive role, and arbitrarily imposes extra work on already overburdened non-Finance managers. Underlying that perception is the fact that most organizations simply don’t have adequate systems or automated processes in place to perform rolling forecasting, and instead rely on manual, spreadsheet-driven processes to collect, distribute, and analyze forecasting data. Such severe limitations prevent forecasting from becoming a business exercise where every department contributes and takes ownership for delivering on their forecasts.  

The core purpose of the forecast is to build trust, by which Finance develops business partnerships that jointly gain greater influence to steer the business in the right direction. You can’t change minds all at once. But, you can change the process and tools those minds use, and help the entire business become more of one mind about its budget and its future.