Whether you are talking about the weather report or a business situation, “forecasting” often comes right before rolled eyes or a dismissive wave of the hand. I have often joked that I’d love to be a weatherman, because I could be wrong a lot and still keep my job. Unfortunately, I cannot use that joke since I started forecasting in my corporate jobs. At least weathermen have state-of-the-art computers to track their weather patterns. Business forecasters often have little more than an Excel spreadsheet and information pulled together through intuition and a lot of badgering. I’m starting to envy the weathermen.
Business forecasting is admittedly a difficult task. We need to anticipate and project future results to make critical business decisions. If business forecasts are to become credible sources of business decision making, the entire business must make accurate forecasting a priority. Too many organizations treat forecasting as an accounting exercise. The accountants spend days at the end of the month compiling actual data, adjusting numbers based on new demand schedules (which are forecasts themselves), applying manual adjustments to numbers that do not “look right”, and call the forecast complete. When this occurs, forecasts often look completely out of line with reality. Several companies have stopped providing earnings guidance to Wall Street analysts in part to reduce the possibility of inaccurate forecasting affecting stock prices.
Forecasting must be a critical part of any successful business’ plan. Forecasting forces the business to ask hard questions about its future and anticipate uncertain events. A failure to forecast is just like traveling to Florida in March without looking at the 10-day weather outlook. You can guess about what will happen, but you may be unpleasantly surprised by the results when they occur. However, the forecast process must undergo significant changes before becoming a valued part of the planning process.
Set a realistic time horizon – Five-year plans are now a waste of time. Imagine a five-year plan in 2003 correctly predicting the 2008 credit crisis. If it occurred, it was likely done by sheer luck. While no business can operate day-to-day with no plan in place, you should only forecast as far into the future as you can reasonably expect. If your business is extremely volatile like retail clothing, your forecast may only last a single selling season. If your business is more stable and cyclical like heavy equipment manufacturing, a forecast of three to five years may be more suitable.
Gather only as much information as you need to anticipate the future – It is extremely important to recognize the different levels of detail between a forecast and a budget. Budgets are very detailed, often being reported by account and department. Forecasts are less detailed and are more focused on the overall business. The devil is in the details when it comes to forecasting. Realize that forecasts contain a high level of uncertainty, and that uncertainty cannot be reduced by asking more detail. Spend more time looking for patterns in the high-level information and how that can help you make decisions.
Forecast based on events, not time – Forecasting is a time-honored tradition at month end for most businesses. Accountants will look at last month’s forecasts, determine how actual results impact those forecasts, and then adjust forecasts. Unfortunately, business does not follow a strict time schedule. In order for forecasts to be useful, you must be able to update them after a significant event occurs. What if your competitor cuts capacity by 20%? What if your main supplier cannot ship a key component? If these events happen in the middle of the month and you do not forecast until month end, you will lose two weeks of relevant information.
Prepare forecasts for multiple scenarios – Another hallmark of forecasting is to provide one number based on a series of “most likely” events. No one can predict the future that well. Forecasting should consider several alternative versions of the future. If you have forecasted several scenarios, you are more likely to react quickly and correctly regardless of what really occurs.
Forecasting can be a valuable part of an organization’s planning process. If a company’s management trusts its forecasting capability, it can react more quickly to save valuable resources. Unfortunately, too many businesses treat forecasting as a financial activity instead of a critical business process. Intelligent companies prepare their forecasts as a key tool to anticipate the future and plan for long-term success.