Advices to improve your Forecast (part 1)

If you can look into the seeds of time
and say which grain will grow and which will not,
Speak then to me.
Macbeth, William Shakespeare

On this occasion, from Steering Bird, online advisers in business direction and management, we will talk about Forecast, one of the important activities in the finance area, which in most cases is responsibility of Financial Controller.

What is a forecast?

Forecasting is very difficult, especially when it involves the future.
Yogi Berra

Forecast is the estimate of future performance. It is not a simple projection, but is an elaborate exercise, with a medium or long-term horizon, which allows better management of the company’s planning. We will talk about business, which is what interests us at Steering Bird, but you can find forecast for practically everything, such as projections of the performance of a particular product, of a country or a region. Even, weather projection is a forecast.

From a management point of view, we will make the distinction between forecast and prediction. This is what David F. Hendry and Neil R. Ericsson indicate in the book “Understanding Economic Forecasts” (2003): “Even so, common usage suggest that the two words have somewhat different senses, as with weather forecasting, not weather prediction. Equally, one might observe that it was predictable that a marriage would fail, but not forecastable when it would do so”.

Hendry and Ericsson (2003) suggest that prediction is more associated with the laws of nature and forecast, with the probabilistic. We will use this distinction in this article.

Financial Forecast

Forecasting by bureaucrats tends to be used for anxiety relief rather than for adequate policy making.
Nassim Nicholas Taleb

Financial Forecast, as defined by the Corporate Finance Institute (CFI) “is the process of estimating or predicting how a business will perform in the future. The most common type of financial forecast is an income statement, however, in a complete financial model, all three financial statements are forecasted”.

The Financial Forecast estimates the future financial results of a company through the review of historical real values. It enables the Financial Controller, or the responsible management unit, to anticipate results based on previous financial data.

The Financial Forecast process is quite long and complex. All the necessary and sufficient information must be gathered to generate the best estimate of the different items that will give rise to the financial statements. Think about what you should forecast on costs, administrative expenses, sales, asset and liability accounts.

Project forecast

It does not do to leave a live dragon out of your calculations, if you live near one.
J.R.R. Tolkien

In project management, you also work with Forecast, on the project flow. The Project Control unit is in charge of its administration.

The forecast of a project allows to manage it from the financial point of view. It allows observing the times in which costs are estimated, according to the construction sequence and the project program.

In this case, it is also an important indicator of the final financial result of the project, allowing estimating indicators such as ETC (Estimate to complete: estimated cost to complete the pending work) and EAC (Estimate at completion: total estimated cost of the project). We will talk about these issues on another occasion.

Main features

The man who has anticipated the coming of troubles takes away their power when they arrive.
Seneca

What characterizes a Financial Forecast is the following:

  • Its objective is to determine how companies should allocate their budgets for a future period. Unlike the budget, the financial forecast does not analyze the variation between itself and the actual performance.
  • It is generally updated quarterly, or when there is a major change in operations or business plans.
  • They can be done for future periods in the short term and in the long term. The traditional is a quarterly exercise (Q1, Q2, Q3, Q4) for the first year and an annual one for the following five years.
  • It allows to introduce adjustments in variables such as production levels or inventory management.
  • A long-term forecast can also be useful for the company to develop or improve its business plan and strategic planning.

Forecast vs. Budget

He who lives by the crystal ball soon learns to eat ground glass.
Edgar R. Fiedler

Previously, we’ve talked about the budget. Perhaps now you are wondering: what differences are there between a Forecast and a Budget?

Let’s start by stating that they are complementary tools. Both are used by companies to develop a plan that indicates where they want to take it (Budget) and to measure whether it is going in the right direction (Forecast). Thus, the budget is a report on where the company is going and the Forecast is a report that indicates:

  • If the company is meeting budget targets
  • Where the company is heading in the future.

Perhaps the main difference is that the forecast is used to make decisions. If the company uses the budget for these purposes, is making a serious mistake or is using flexible budgets, that must be updated regularly. From this, it follows that the budget provides a vision “of a specific moment”, without reflecting changes in the market.

Another important difference is that the budget must be compared with the real values, while the forecast does not. In practice, we recommend making a budget vs. actual / forecast, integrating the three variables within the analysis.

We are Steering Bird, online advisers in direction, management and finance. We specialize in business analysis, control and analysis of investment projects, results analysis, processes of budget and forecast, etc.

Contact us if you need help. We invite you to learn about our services and read our articles.

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