Now it’s time to do your forecasting model
Creating a forecasting model is a more dynamic process than creating a budget. As the year progresses, a forecast model generally becomes a more accurate representation of the trajectory of the business because it’s continually updated based on actual results and changes.
For example, if the budget included a significant client that departs during the year, the forecast would have to be modified to remove the revenue from that client. But the original budget would not change. By factoring this revenue loss into the forecast, a business owner will be better able to see the impact that this loss will have on the projected results and can make changes in expenses or other areas of the business to mitigate the losses.
Understanding discrepancies between the forecast, the budget, and actuals, which can either be expenses or revenue, can help determine a realistic growth target.
How to create a forecasting model
There are different ways to develop an accurate, efficient forecasting process. Start with the budget, as that will be the most accurate initial projection of the growth target for the business at the beginning of the year.
Realistic assumptions should be built into the forecasting models to ensure the growth potential is achievable and decisions are being driven by accurate models.
Once actuals are incurred, compare them to the budget and determine if the variances are actual variances or timing variances.
A timing variance will be resolved in a future month. For example, if a project was budgeted to start in one month but was delayed, you’d see a variance in the month it was budgeted as well as in the month it happened. These variances would offset assuming the project continued to completion, but the month it happened would differ from when it was budgeted.
An actual variance would occur if the budgeted projected was canceled.
You would need to update future months’ revenue and expenses in the forecasting model based on any timing and actual differences. Determine what changes need to be made to achieve the planned growth targets established during the budgeting process.
Software to make the process more efficient and cost effective
To make forecasting easier, you can rely on a range of tools such as:
- Microsoft Excel® models
- CRM software like:
- Salesforce
- Monday Sales CRM
- Microsoft Dynamics
- Forecasting software such as:
- Cube
- Workday Adaptive Planning
- Anaplan
- Oracle Hyperion
- IBM Planning Analytics with Watson
Forecast models help determine what happens to your business when your budget projections aren’t met
Maintaining a forecast model is critical in determining whether growth targets are achievable when the actual results differ from the budget during the year. This allows you to make real-time adjustments to your projections. That helps you understand where changes may need to be made to achieve business goals or pivot to a new strategy.
If a budget was created with an unrealistic revenue target, the forecast can be adjusted to update the revenue target and determine what changes are needed in the expense projections to achieve the desired growth.
Let’s say a business owner gives employees raises based on aggressive revenue projections. But shortly into the year, a key client goes out of business, significantly impacting on the revenue projection for the year. A forecast model can help determine the impact unforeseen circumstance will have on the business and allow you to map out different scenarios to maintain expenditures such as raises, decrease other variable costs, and achieve a realistic goal despite the decline in revenue.
An effective budgeting strategy is to create revenue projections that are realistic and conservative, with expenses budgeted to support the revenue. If revenue does not reach budgeted goals, use the forecast model to identify expenses that can be reduced in the forecast. On the other hand, if revenue exceeds budgeted goals, a forecast model can help you assess if expenses can be increased to support additional growth while maintaining original margin projections.
Maintaining a forecast and identifying variances to actual will allow a business owner to react quickly and determine attainable growth targets.
How to effectively update a forecast model to ensure achievable growth targets
The ability to identify the variances between budget, forecast, and actuals will prove beneficial when you’re trying to look ahead.
If a business is experiencing favorable revenue variances, they may need to consider hiring more or increasing operational costs to accommodate the growth.
Expense variances should be reviewed and understood to ensure timing or actual, and if changes are needed to either increase or decrease those costs.
Referring to the original budget will help drive decisions toward the original growth target. Having an accurate revenue forecast will drive the expense forecasting process to ensure growth targets are achieved. By updating and maintaining the forecast model, you’re able to identify changes that need to be made to achieve the growth targets when variances occur.
The importance of accurate data for a forecast
The forecast will only be as accurate as the data you put into the forecasting model.
Establishing a solid month-end closing process with policies and procedures in place will ensure that the actual financial information is accurate and can be relied upon to make future decisions.
Data used for the forecast model should be based on sales projections, including existing clients and new clients in the sales pipeline. Cost of sales will be projected based on money needed to support those sales projections. Administrative costs are generally fixed, based on prior month actuals or knowledge of administrative needs to support the pipeline. The data should also be based on prior month actuals, new client contracts being signed, and a solid understanding of the expenses needed to support additional revenue.
Forecasting models can help create achievable growth goals
Developing an accurate forecasting model will have many benefits in setting achievable growth goals for your business.
Creating a realistic, manageable budget, understanding variances as they appear — what caused them and what they represent to progress towards your financial goals — and then being able to update your forecast based on changes all contribute to achieving your growth goals.
