Strategic Forecasting

I have mentioned forecasting in my blog a few times, some people refer to forecasting as budgeting, which can be a much more pain inducing process. I like to refer to strategic forecasting as beginning with what we know about the organization, add in trend analysis for the major drivers, as well as the growth or changes coming from the Strategic Plan of the organization.

We begin our journey with the drivers of Net Revenue, once we have mapped out what we expect to see happen there we can begin looking at the costs. Some of those costs will be fixed and easy to calculate. Others are going to fluctuate or be variable depending upon the amount of activity in the organization. For the variable costs, you need to determine how they relate to the generation of Net Revenue. This will allow you to forecast them in a reasonable manner. Your fixed costs are generally easier as they will not be changing as Net Revenue changes.

Once the forecast has been created, it is important to review it to make sure that it is reasonable and can be executed against. The problem with budgeting and forecasting is not the difficulty in creating the budget or forecast but in the organization being able to execute against it. If you have forecasted that Cost of Goods Sold (COGS) will be 30% of Net Revenue and COGS is historically 35% of Net Revenue, you had better have a realistic executable plan for reducing 5% out of the picture. At the same time, just because the historical number is 35% nothing is stopping you from asking what it would take to reduce it to 30%. That’s how a plan comes together.

Just having a forecasted P&L statement is not the goal of Strategic Forecasting. You next need to forecast the Balance Sheet. You begin with the historical Balance Sheet and determine how the different lies relate to the historical P&L. Once you have determined those relationships, you can then forecast based upon your forecasted P&L. It is also helpful to then forecast a Cash Flow Statement combining the forecasted Balance Sheet with the forecasted P&L.

Now that you have your three forecasts completed, you need to analyze them for reasonableness in addition to asking the question, do these forecasts take us to where we want to go? When your forecast does not take you to where you want to go you need to determine why and what needs to be changed. Then you need to change it.

Finally, I find that forecasting works best if it is refreshed and extended each quarter. While you are refreshing it and adding actual results for the prior quarter, you can test the relationships you built the forecast upon and adapt them as needed.

@ Strategic Financial Leadership, Inc.