Most large organization spend a considerable amount of resources performing some type of financial forecasting. Conversely, small and medium-sized businesses spend less time on planning for the future. Larger organizations have more to lose, therefore, the need to actively assess changes in the market to take advantage of opportunities or avoid risks becomes a more urgent priority. All companies, regardless of size, can garner economic rewards through financial forecasting.
So why don’t more companies do it? Because it is HARD to do well that’s why and let’s face it, no one likes hard work. By keeping the below common pitfalls in my mind, any financial forecaster, regardless of company size, will have a clearer picture of their future financial prospects.
1Forecasting Sales NOT Products or Service
Most financial forecasts pivot off a sales forecast, which makes how the sales forecast is created critical to the success of the overall financial forecast. If you have 3-5 years of historical financial data, it is easy to assume an ongoing trend with a constant growth rate. This type of sales forecasting can produce a very accurate looking projection over the short term but it is an accident waiting to happen.
The idea of driver-based financial forecasting has been around for years and the premise is simple, don’t forecast the P&L line item, forecast the drivers of the P&L line item. For example, if you sell widgets, don’t forecast the total sales of widgets, forecast the number of widgets you intend to sell and the expected prices you anticipate to sell them for.
Why does this nuance matter? Because customers do not buy sales from a company, they buy widgets and if you forecast only sales; changes in price and quantity may be hidden and offsetting robbing you of valuable insight, preventing you from taking action when a trend changes. This also allows you to adjust pricing assumptions quickly to take into account competition.