There's no doubt that a forecast is of prime value to a business - who wouldn't want an insight into the future of their company?
How do you build a forecast that you can rely on with confidence, as a key tool in strategic and tactical decision making?
Below are a few considerations to take into account when developing a forecast, to make it relevant and reliable.
Work Bottom-up, not Top-downThere are two basic approaches to preparing a forecast. Top-Down forecasting is based on an estimation of potential market share that your business can capture in its industry, giving a sales figure to base the rest of the forecast on. By contrast, Bottom-Up forecasting begins with an 'operating expense plan', examining the projections of each department and the operations capability of the business, and combining this to create a realistic forecast.
So why is Bottom-Up better?
- Based on fact, not opinion - estimating a market share gives scope for unrealistic assumptions about future growth, but being aware of business capabilities and trends based on past data makes the forecast more realistic.
- More specific - forecasts can be built around department, product, location, or any other variable, rather than assigning an average from a notional sales figure. This can be very powerful in allocating resources correctly.
- Employee involvement - getting feedback from staff members will not only keep data accurate but will give employees ownership of a number that they can manage, improving engagement and accountability.
- Focuses on net profit and return on investment as a number one priority rather than just seeing what profit results, if any!
Obviously, market conditions have to be taken into account in any forecast, so a hybrid approach tends to be the most relevant, accounting for all relevant factors.
Strike a balance between detail and usabilityTo make a forecast useful it has to be detailed. Numbers must relate to specific costs so that actual performance can be compared meaningfully, and variances analysed - over-generalisation will hinder the usefulness of a forecast. In the same way, getting bogged down in unnecessary detail will make the process inefficient and costly.
As the diagram shows, the balance struck is essentially a cost-benefit decision, based on the cost of forecasting, and the cost of potential inaccuracy.
The right level of detail will depend on your specific circumstances - for some companies it may be relevant to use detailed statistical analysis, for others a simple projection of past data may be accurate and reliable. Ultimately, striking a balance will come as a result of experience, and a competent financial adviser should be able to help you.
Keep it liveMany will have heard a forecast described as a 'living document' - it has to be kept alive to the changes and reality of your business. Updating your forecast on a rolling monthly or quarterly basis will keep it relevant and accurate, and ensure that it stays in touch with strategy and market conditions. Run different scenarios to test the effect on your figures, and challenge the underlying assumptions in each number. Doing this means you can be confident the decisions you make are valid and informed.
As can be seen above forecasting is a very important tool in a business's arsenal but it is imperative it is closely monitored and kept up to date to ensure your long-term competitiveness and profitability. Need help with creating a robust forecast or financial plan? Connect with our friendly team today! Contact us here
Please note: This report is provided for information only and was correct as at time of writing (17/06/21). Lists and details provided above are not exhaustive and not intended to be full and complete guidance. No action should be taken without consulting detailed legislation or seeking independent professional advice. Therefore no responsibility for loss occasioned by any person acting or refraining from action as a result of the material contained in this article can be accepted.