Effective Financial Forecasting - Part 2
/Note: This is the second post on effective financial forecasting. You can read Part 1 here.
Given the challenges of forecasting and its importance to organizational management, companies must find better ways to manage forecasting. Fortunately, leading companies are finding ways to make the insights from the forecasting process more meaningful. Listed below are five steps a company can take to transform the forecasting process:
- Integrate Forecasts: The financial forecast will never be accurate if it is developed independently of other forecasts. Line items in the financial forecast should have direct ties to forecasts and planning assumptions made by Sales and Operations. All groups should be using a common set of drivers and assumptions regarding the economic outlook and the expected demand for the company’s products or services. A key benefit will be increased communication between departments.
- Leverage Technology: Performance Management is one area that has lagged in the area of technology investments and integration. An effective forecasting process will have an application dedicated to the planning and performance management process to enable web-based data entry and automated roll-ups based on the reporting structure.
- Reduce the Level of Detail: Most forecasts could benefit by dramatically reducing the level of detail. Every forecast should minimize the level of detail needed to forecast revenue and profitability. Attention should be paid to those key line items that drive changes in the forecast.
- Implement Rolling Forecasts: Business events do not follow the artificial distinction of a fiscal year end. An effective forecasting process uses a rolling forecast to project beyond the current fiscal year. Six quarters is typical but it can vary by company and industry.
- Drive Cultural Change: Ultimately senior management will set the tone for the forecasting process. If managers know they are going to face a backlash for telling the truth, they will continue to game the system and submit unrealistic forecasts. An environment must be created where there is an incentive to create accurate forecasts and where managers have the political support to do so.
Conclusion
By following these best practices, companies will be able to reduce the time and effort required to develop a usable forecast. With improved forecasting, companies will have an effective tool for executing strategy, allocating resources and communicating expected results with key stakeholders.