A Good Forecast is Better Than a Good Budget

Your company’s budget is an important tool, but it is short-sighted in scope.  A properly prepared forecast can be infinitely more helpful in planning your company’s future. However, it is not uncommon to walk into a company, ask for a forecast, and be told that one doesn’t exist. A forecast is a tool that helps you see farther out into the future, and a good one can be used for many things.  If your company is engaged in scenario planning, a solid forecast can be the foundation for your scenario planning.  I have constructed forecasts for many reasons including but not limited to – sales forecasts, production forecasts, expense forecasts, cost of goods forecasts, and cash flow forecasts.  I think companies should engage in forecasting for a minimum of at least 5 years in the future, but extending it out to 10 years is even more helpful. My preferred forecast model extends out to 10 years.

Not Having a Forecast Can Put Your Company at Risk

Not having a forecast means that your company is not planning for its future.  In a company with no forecast beyond the current budget, you have myopic vision.  Forecasting farther out means being able to anticipate opportunities, as well as threats.  Looking farther ahead helps you anticipate financing requirements, equipment purchases and labor additions.  Being rigorous around forecasting, helps predict when swings in your business are likely to occur and enables you to plan for those swings.

Sales People Aren’t Always the Best Forecasters

Sales people are naturally optimistic, some might say overly so. Their jobs depend on them being that way. From my experience, they are especially bad at forecasts. They are prone to produce what I like to call “happy numbers.” It is a natural extension of their background and position.  Who wants to hire a salesperson that says “I don’t think it can be done?”  No one would. I’m also not sure that a salesperson who says that is still working in sales.  They are predetermined to turn in optimistic numbers – to be the cheerleaders. In one company I worked at, I took whatever annual forecast the salespeople gave me and cut it in half.  It was a pretty good approach.

A Poor Forecast Can Really Disrupt Your Business

If the sales department puts out an unrealistic forecast, huge disruptions and unnecessary cash expenditures can result.  A “happy” forecast can result in too many raw materials being purchased.  Depending on their expiration dates, they could go obsolete before they are needed on the production line.  On the extreme end, too high a forecast could result in excess manufacturing capacity being built and too many people being hired to staff production lines that aren’t needed.  Large amounts of resources can be dissipated by an unrealistic forecast.  On the other hand, if your forecast is way too low, you will be on your heels playing catch up – trying to find production materials, trying to hire people quickly, and missing revenue opportunities.

Be Willing to Get Input From Others

From my experience, the number one hazard of forecasting is becoming enamored with the process and ignoring the results.  When your forecast is complete, it is critical that you step back and ask yourself, “Does this make sense?”  It is also helpful to gather a team in a conference room and start reviewing the forecast together.  Invariably, someone always spots something that can be calculated better, improving the forecast.  As the forecast builder, it is important to get input from others – the more people engaged in the process, the more sound the final result will be.

Forecasting is An Art

Sometimes it is tempting to take a 5-10 year forecast and turn it into an accounting exercise.  A forecast model can include hypothetical R & D projects, new product launches, and capital forecasts for the retooling of manufacturing plants.  It is difficult, if not impossible to drive down to a low level of detail on every line item of the forecast. A good forecast necessarily has holes in it.  The trick is to minimize the places where the forecast is soft, and being aware of where the weaknesses are.  The best forecasters in the business have trouble nailing it every time – the Fed does an outstanding job of forecasting economic shifts, but it still misses important signposts.   I live in Los Angeles, where you  would think a weather forecaster could say “sunny and in the mid-seventies” almost every day and be right 97% of the time, but it is surprising how often they miss. Forecasting anything takes knowledge, a good model, a lot of hard work and a little alchemy.  Forecasting takes time and requires experience to do it well.

Forecasts Come in Many Flavors

There are many ways to build a forecast.  For business purposes, I like to build forecasts that link the three financial statements – income statement, balance sheet and statement of cash flows.  I usually hook it to a financial ratio page that also shows the effect of the forecast on the company’s financial ratios – profitability ratios, performance ratios and leverage ratios – to look for potential pitfalls the company may be heading for.   I like to take that platform and use it as a starting point to build scenarios.  At the end of the forecasting process, we will have a pretty good idea what some of the key drivers of the business are, what a realistic picture of the business is over the coming years, and we have a handful of scenarios in our toolbox with some strategies for growing the business or reacting to external factors when they rise.

Improve Your Vision

Businesses really benefit from a forecast that is well researched, fully thought out, built using a solid mathematical platform, and has been screened and critiqued by a large audience to ensure no gaping holes exist.  Your company depends on a good forecast. It allows you to broaden your horizons and “see farther.”

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