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Forecasting Mistakes that business make

Anyone (owners or finance professionals of small, medium or large companies) who have tried to make a forecast will likely know that sinking feeling when they realize that the forecast has failed to materialize, and there is no explanation to justify the variances. Even in scenario's where the variances are known, in most cases, the justification is mainly because of an enthusiastic commitment, at best, or an overly adhoc imagination, at worst. In either or the scenario's, these variances often point out to the shortcomings in the forecasting process.

Forecasting is process in which a list of clear, realistic, action-oriented, quantifiable and time-bound assumptions are summed up and consolidated with the actual performance to get a holistic view of the key business KPI's. The usage of forecasts could range either to confirm the health of the business, or to make long-term strategic decisions, or validate viability of certain initiatives. Regardless of its use, it is imperative to have a robust forecast whenever one is made. Alternatively, business shouldn’t spend time on it if the management does not consider it as a priority.

This blog is intended to help businesses, particularly the small and medium sized ones, in highlighting the common mistakes business' make while preparing and consolidating the forecasts. While a final output of the Financial Forecast will have P&L, Balance Sheet and Cash Flow, every report will have different sections (like revenue, cost, expenses, capex, etc.) which needs its own focus and methodology for accurate planning.

In this blog, which is a part of the "Improve Forecasting Accuracy" series, I highlight the mistakes that are made even before the process of forecasting has started. Rectification of these mistakes involves a change in mindset and culture of the business, that will not only reflect in the enhanced quality of forecasts, but also have long-term implications and benefits to the performance of the business.

1. Understanding the difference between accountability and responsibility - first and foremost, businesses assume that the person making the forecast is fully responsible for achieving it and are expected to justify the variances from actual performance. this is wrong at multiple levels. the person driving or preparing the forecasting process is accountable for the forecast and is definitely responsible for the accuracy of its consolidation, he / she is NOT the person responsible for its success or failure. It is the responsibility of the key stakeholders in the business that have to contribute their bit to the forecasting process, and make it as smooth as possible. secondly, the variances should be highlighted by the person preparing the forecast, while the justification needs to come from the responsible department that have caused a disrupting variance.
    
2. Bank balance is NOT profit - This is by far the worst assumption business' often make as a starting point. often the plan is based on assumption that the liquid cash is what the business' can spend to achieve their long / short term goals. It could be that while the business is making a loss, there is adequate bank balance because it may have to pay a lot of vendor or supplier invoices which are yet to be accounted. In reality, there is a whole separate exercise for forecasting the cash flow or working capital of the business, but the first step to any forecast is to get a consensus on which direction the profitability of the business is headed towards, understanding the liabilities and other aspects of the business.
    
3. Ensuring a solid starting point before getting into the forecast – Often it is assumed that the data in the ERP is good enough to kick-off the forecasting process. In many cases, businesses are not managing accounts on any ERP, or the way the business has been setup on the ERP is meant only for statutory purposes and doesn’t have the adequate detail necessary to provide the clarity on how the business performance has been to-date, leave aside department performance. Businesses should ensure that they make maximum utilization of their ERP systems, and ensure that all details of department activities are recorded. This will give the confidence to the forecast as it eliminates any impact caused by administrative or behavioural errors.
    
4. Forecasting is a consolidation of 4-Ps and nothing less – Even when there are excellent forecasting processes in place, often it is noticed that the they are a consolidation of only the known facts detailed and documented. While this is good, a solid forecast is something that is a consolidation of 4-Ps namely.
   a) Pending - Firms commitments that the business is yet to deliver or service in the future
   b) Planning - Opportunities at the closing stage where business is waiting for commitments from the client and is confident of securing and delivering it
   c) Projecting – Early stages of Sales phase, or Initiatives that are yet to be kicked-off
   d) Pushing – A tops-down challenge or action pushed by the management to meet or beat expectations or targets.
   While every P will have a different weightage depending on the time of forecasting, it is imperative that all these 4 elements are factored in during the build-up of the forecast.
    
5. Curbing over Enthusiasm or conservatism and consolidate for a realistic scenario – This is probably one of the disadvantages of relying on too many department heads for the purposes of forecasting. People have different styles of managing their affairs, and it could range from having an over-enthusiastic sales team to a slightly conservative operations department. There should be gatekeeper who is in charge of levelling out these emotions out of the process, and ensuring the forecast is robust and realistic.

While the above are strict “don’ts” for baselining the process, knowledge about factors such as probability, risk assessment, contingency, economics are equally important that help build up accurate forecasting. We will start explaining these once the basic “mistakes” are covered for all sections.

In the next post, we will get into details about improving forecasting on the P&L side of business.