Even in stable environments, it can be extremely difficult to forecast the future for your business. And yet, running a business without a plan can be disastrous. At best, you may be leaving opportunities on the table. At worst, you may not see a catastrophe looming until it’s too late to change course.

Our advice is to do away with the traditional budgeting process around an annual planning cycle. The point of any exercise must be to add value in managing the business. Traditional budgeting often fails this test for several reasons:

waterfall

Waterfall reporting and rolling forecasts make for a more foreseeable financial future

  • Traditional budgets often take months to prepare and become obsolete quickly
  • Companies build too much detail into the budget, making revisions and reviews overly cumbersome
  • Traditional budgets are often based solely on last year’s numbers and don’t encourage the management team to analyze competitors or the market
  • The budgeting process tends to focus only on items like “revenue” and not on things like “customer satisfaction”, which is one of the key drivers behind revenue
  • Traditional budgeting leads to game-playing where managers try to negotiate low targets to reach maximum benefits
  • Traditional budgeting involves “forecasting to the wall”; companies create one budget for 12 months and as time passes, the wall looms ever closer. What benefit is there to have a 12-month forecast in January, but only a 3-month forecast in September?

Innovative companies have replaced traditional budgets with continuous planning and rolling forecasts. We typically recommend using a 5-quarter rolling forecast. As each period comes to a close, the management team evaluates actual results and changing opportunities in the marketplace and reforecasts out the remaining periods. Action plans should be developed during this review process to correct negative trends or exploit positive developments.

Best practices for implementing rolling forecasts:

  • Focus on critical drivers, not excessive details. If your plan includes line items for “office supplies” and “miscellaneous expense”, but you have no metrics for customer ROI or customer satisfaction, you are likely focusing on the wrong things.
  • Move from fixed performance to relative improvement. For example, if your target is to grow your same-store sales by 3% and you achieve it, but your competitor grew them by 6%, you’ve met your target but failed in the bigger picture.
  • On the expense side, move from hard dollars to relative dollars. If your travel expenses are 300% higher than plan, that sounds terrible, but what if your sales staff closed four new contracts that month, a new company record?
  • Move from fixed incentives to relative rewards. How many times have you heard about baseball players having a phenomenal year when they are about to go on free agent status? In traditional systems, a bonus is given when you hit your target. Instead, provide compensation with hindsight – a bonus is earned for economic value added.

 

One of the pitfalls of rolling forecasts is the tendency of management to try to make up a shortfall by pushing unrealistic favorable results into future quarters. A good tool for managing this phenomenon is the waterfall analysis. This is a simple chart that compares actual results across time periods against your original plan as well as against rolling forecasts you made along the way. Waterfall charts provide value by:

  • Displaying how we are doing against our original plan and against each adjusted forecast
  • Predicting where we will end up at the end of the fiscal quarter or year
  • Holding CEOs and the management team accountable for their forecasting and encouraging improvement in forecasting skills

Here’s how it works. Across the top is your original plan, let’s say, units sold. Each column is a time period, we’ll say months. The next row is month 1, January, where we will plot in our actual results, followed by 11 months of forecasted data. The rolling forecast data may or may not change from our original plan, depending on how management feels the marketplace is responding to its efforts. The following row is month 2, February, where we will plot our actual February results, followed by 10 months of forecasted data, and so on.

Would you like to learn more about rolling forecasting or waterfall analysis? Let us know in the comments below, or talk to one of our CFO advisory service professionals today!

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