Will Your Next Annual Forecast Make You Look Smart?
Written by The One Page Business Plan Company, on April 14, 2021
“It’s tough to make predictions, especially about the future.” ― Yogi Berra, famous baseball player
Business plans and forecasts are difficult to get right. Most of the time, projects take longer than planned, cost more than expected and are full of surprises. Even if the project exceeds forecast and sales are higher than planned, unplanned success brings its own set of problems, like working capital stress, materials shortages, and poor customer experiences.
How well equipped is your team to lay out what the future will hold, and to stay committed to that path? It is not enough to have a great team who can get the job done and a marketplace ready to buy. (Executives must predict the future with enough specificity to plan in detail, so they have what they need, when they need it.)
Effective forecasting also provides the opportunity to strike bargains with the external parties we will need for success. That includes investors, public markets, suppliers, contract manufacturers and others. If we want to gain their trust and access their resources the next time we come to the table, we must deliver on our promises this time—and hit our targets on our business plan.
If we are likely to miss our forecasts, we must reserve more cash to handle the surprises, or perhaps even to make a second try for success. Firms striving for growth are just as susceptible to running out of cash as firms that are shrinking. Simply put, they can spend too much too fast, or spend too little too late.
One distribution firm created a forecast for closing one facility and shifting production to another state. It took twice the time, 70% more in cost, and shipment of goods was far more adversely impacted than was forecast. The miscalculation hurt the firm badly, breaching bank covenants.
Forecasts like that can make you look stupid…
So, what are the best predictors of forecasting success?
Past Forecasting Performance of the Company
If a company has previously been successful in forecasting, there is a strong likelihood they’ve acquired that competency. It matters that most of the same people are on board. Also look to the kind of forecasts they succeeded in making on past business plans. Forecasts for a line extension or new service line can be difficult, but they’re not nearly as complex as a large acquisition or developing a new business unit in a nearby adjacency.
If the past forecasting performance of the company is poor, look out!
Past Forecasting Performance of the CFO
While many people will provide input to your forecast, there is one person—often the CFO in a mid-market company—who drives the forecast. That person’s track record is crucial. Only through much experience can a forecaster learn where slippage usually occurs. They know where the surprises often lurk. Additionally, and most critically, they learn to include the costs and items which inevitably make an impact on the forecast but are usually overlooked.
Creating the forecast is only the first step. Staying on forecast requires an active financial manager, who not only monitors what has happened, but projects what is going to happen—or fail to happen—in the immediate future. Having such a CFO on board (or acquiring one) significantly increases your accuracy of forecasting, provided this person is not overruled too often, or sidelined.
Past Commitment to Hitting Forecasts by the CEO
Companies often miss forecasts because the CEO he or she may decide that priorities have shifted and want to pursue another direction or may panic and start to look for other solutions. In some cases, the CEO just does not like the discipline of sticking to plan.
It is true that circumstances sometimes call for a change. Yet this implies that the management team was unable to foresee the situation when the forecast was originally created, a failure just as bad as undisciplined spending or insufficient sales.
The CEO can single-highhandedly cause the company to miss its forecast. Looking at his or her past behavior is critical to any assessment of probability for hitting the next forecast.
Number and Clarity of Fallback Plans
It is naïve to think that the path to hitting a forecast is a straight line. Management must usually make significant adjustments along the way. In a mid-market firm, those adjustments must come early, before too much damage (over-spending, missing critical timing windows) can be done.
Good forecasters identify the areas of risk up front, building in triggers that spur implementation of backup plans to keep on target. The presence of triggers—in writing—and the visibility of those triggers increase the likelihood of staying on forecast.
In the case of one manufacturer of hard drives, the firm was just coming off a poor quarter during the 2008 and 2009 financial crisis. The team knew they needed to make some tough decisions and cuts to the organization. In doing so, they focused on preserving a initiative in developing their next generation product… but had to make cuts in sales and other teams.
They built a longer-term plan around preserving cash, focusing on delivering the next generation product and then adding more salespeople as things improved in the macro environment. The plan was a long-term business plan that drove the organization to certain metrics and profitability was critical to enable a possible exit in the public market. As it turned out, the sales team delivered, and the firm was ultimately sold at competitive multiples to Hitachi Data Systems.
The Likelihood of Distasteful Consequences If Management Misses Its Forecast
The stock market punishes public companies immediately if they fail to meet their forecasts. As a result, they are more likely to pour time and effort into setting realistic benchmarks and fighting hard to achieve them. Yet in many private companies, missed forecasts are met with shoulder shrugs. There are no consequences for poor forecasters.
In fact, there is often more pressure to agree to an overly optimistic forecast than there is to achieve the forecast. This is a mistake of great consequence. Pressure to perform is a critical factor in all business operations. Identifying missed forecasts as failures and delineating serious consequences for those failures increase your likelihood of hitting forecast.
If we have confidence in our forecast, we can spend more aggressively. If we do not, we must hold more cash in reserve, to allow us to recover from surprises or potentially to try again. Determination of optimal spending velocity stems from understanding the level of market predictability, the proven ability of your team to execute, and the likely accuracy of your forecast.
Spending too much too fast can leave a company at a dead end—with no money to shoot for success a second time and owning a track record that won’t impress any new money sources. On the other hand, spending too cautiously when a strong team sees a strong opportunity often results in the loss of that opportunity to competitors.
Before you lay down a significant bet, spend time and effort on assessing market predictability, execution competency and your team’s forecasting acumen. Then make the decision about your spending velocity and the level of risk that is prudent!
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