Budget for better financial forecasts

How your business performs this year can depend very much on the forecasts you made last. The nature of the exercise has traditionally been to look at a historic period, typically the previous 12 months, and use that to budget for the next. Whether or not that’s the best way to go about things is increasingly open to debate.

This is because of the advent of a new kid on the budgetary block, the “rolling forecast”.

"When it comes to setting your budgets at the start of the year, you forecast sales, costs and profits. These are set, so that you know what you are aiming for and what you have achieved, or not achieved, at the end of the year," says Teresa Morahan, partner and head of audit at BDO Ireland.

As the year progresses, it’s easy to see whether or not you are on track with those projections, and take remedial action.

At least, that’s how life was. “With rolling forecasts someone takes the budget and when, say, four months is past, they say, “Well we’ve four months of ‘actuals’ to date, I’m going to update the forecast. Then you forecast for the next 12 months from there.”

The method allows you update projections to factor in external changes, such as Brexit. There might be a foreign exchange change or, if you’re in the travel business, you might predict a fall in UK tourism, for example. Things happen, and so you constantly update your forecasts to take account of that.”

But there are downsides too.

“For a start, it is costly and time consuming. You need to be asking people for inputs all the time,” she says. The quality of those inputs depends very much on the quality of your data systems, as well as the inputs from line managers.

Because it involves constantly moving the goal post 12 months hence, it can hide variations in performance in a way that is harder to do when “doing the budgets” is an annual event.

The value in historic forecasting is that you know what you were expecting, and where you surpassed, or exceeded it. Knowing that helps you identify areas of strength and weakness.

“With rolling forecasts the risk is that if you don’t achieve your forecasts, you just say, ‘well we’ll do so now’,” she says. “For it to work well it depends very much on having a good level of analysis behind it.”

With historic budgeting, a day of reckoning always comes. With rolling forecasts “there can be a feeling that you are putting things on the ‘never never’”, she says.

“Rolling forecasting doesn’t work without someone to explain the data, so it’s of more use to larger organisations that have the resources to manage it properly.”

If you are going to opt for them, your organisation needs to be agile enough to respond to constantly revised data. That can put pressure on staff.

“It needs a sophisticated finance department and being able to react to them is key,” she says.

“CFOs (chief financial officers) can’t drive growth, that’s down to sales. But they can, through budgeting and how they manage costs, drive profitability, and accurate forecasting has a role to play in that.”

Einstein

It's a role that is likely to be enhanced as more data analysis tools emerge. Customer relationship management software specialist Salesforce has devised a product, Einstein, which uses artificial intelligence and predictive technology to support financial planning.

“Anyone doing financial planning has to look at sales, and what Einstein does is use predictive technology to identify opportunities. A CFO’s performance is based on their confidence to be able to predict the numbers. In any business it’s the sales that generate the revenues that are used for budgetary planning,” says Carl Dempsey, vice president solution engineering EMEA at Salesforce.

When it comes to planning, there is certainly room for such support. “Forecasting is not an exact science,” says Cormac Mohan, vice president of Certified Public Accountants Ireland.

“Rolling forecasting is continuous planning and a lot of firms are moving towards it, to eliminate the time-consuming annual budget process. It means that, in the event of an external or internal factor occurring, you are not working off a redundant budget, religiously sticking to something that has become redundant five months into the year.”

And while it initially emanated from large US multinationals, it can work for SMEs too, he says. “It can work well in sectors where cash flow is difficult or challenging. If, for example, you are a low margin business in retail, where you are constantly micromanaging your payments and receivables anyway, it might suit. Companies with big capital expenditures, such as hotels constantly investing, might find it works too.”

Done correctly, it doesn’t so much put pressure on line managers as empower them, he reckons. “It does away with the sense that budgets are handed down from on high without any input from line managers. With rolling forecasting they take ownership of it.”

It also does away with hidden costs, such as the pressure line managers can feel to “spend” leftover budget for fear of losing it next year. “It requires a steep learning curve, but when a business is in a competitive sector, rolling forecasting can help with better decision making, and allow businesses to react faster. But it’s not going to work for passive businesses, only growth ones.”