The 3 F's That Make for Better Forecasts in FP&A

Weather forecasts tend to be something people either check incessantly or hardly at all. When people do check, they use the data to inform decisions, like bringing along an umbrella when precipitation is likely, or leave their jacket behind when temperatures are predicted to rise. If you're not in the habit of checking the weather, on the other hand, you have to deal with whatever happens - as it happens - which sometimes leads to sweltering, getting soaked or worse.

Finance departments can't afford to let organizations ignore the forecasts they produce, because the potential fallout is far greater.

When forecasts are valued - not just by the CFO but those across other departments and even the board - they influence everything from go-to-market strategies to cost containment initiatives, resource allocation and more. When they're not, targets can get missed, much-needed staffing or equipment isn't in place or customer satisfaction plunges.

Unfortunately, unless the quality of forecasts become so poor they are ignored or lead to bad decision-making, FP&A teams might not be quick to reevaluate the way forecasting is done, or make significant moves to improve or optimize them.

In some organizations, however, the drive to become more customer-focused, innovative or purpose-driven might help galvanize forecasting processes to be reimagined and taken more seriously. After all, anything that contributes to those kinds of broad-based business objectives will require capital for investment and tie back to revenue and other considerations that a good forecast can help support.

While the nature of how this plays out will vary from one company to another, recent research suggests there are a few key areas to bear in mind for FP&A teams that want their forecasts to become not only a measurement tool, but an instrument of value creation:

1. The Best FP&A Forecasts Are Fast

In its most recent Planning and Management Accounting Open Standards Benchmarking survey, which includes responses from more than 1,400 business entities, productivity and quality control research organization APQC notes that top-performing firms can prepare their financial forecast in eight days or less. The poorest performers take at least double that, or longer.

According to APQC, that matters, because forecasts that are slow to produce may be less relied upon by other parts of the business, compares with those that can keep up with the pace of what's happening across sales, marketing and other functions. The analysts suggest using "cycle time" in forecasting as a metric to track the performance of a finance department's contribution to the health and growth of the business.

"Chances are, organizations in that bottom quartile have a forecasting process that's heavily dependent on manual work…in addition to taking a lot more time, this kind of judgmental forecasting tends to be less accurate, because it's easy for key drivers of performance to get overlooked."
- APQC

"Chances are, organizations in that bottom quartile have a forecasting process that's heavily dependent on manual work," APQC says. "Time delays are also often the result of a lot of guesswork involved in forecasting, based on subjective input from a lot of different people. In addition to taking a lot more time, this kind of judgmental forecasting tends to be less accurate, because it's easy for key drivers of performance to get overlooked."

2. The Best FP&A Forecasts Are Flexible

It probably comes as no surprise that forecasting is an area of ongoing study by the experts at Harvard Business School. As a pair of its professors recently explained in an article for the Harvard Business Review, for example, an analysis of forecasting at multiple large, successful companies has shown short-term thinking simply doesn't work.

In fact, the authors suggest forecasts project operating and resource needs over a three-to-five year period, while keeping the nature of the business sector in context, growth rates based on competitive dynamics and input from non-financial teams. These forecasts are appreciated not merely for being accurate - because sometimes, quite frankly, they're not - but by the extent to which they allow leadership teams to learn.

"The forecast is a living instrument and should be periodically updated to reflect any changes in circumstances. Amendments to the forecast are particularly important for firms in evolving business environments or firms that are transforming," they write. "Such forecasts embody the view that things do not typically go according to plan and there is value in taking a first step, adjusting, and then continuing to head in the most promising directions."

"The forecast is a living instrument and should be periodically updated…things do not typically go according to plan and there is value in taking a first step, adjusting, and then continuing to head in the most promising directions."

- Harvard Business Review

3. The Best FP&A Forecasts Are Forearming

None of this is to say that forecasts are just some kind of intellectual exercise, or a way of pointing towards potential opportunities. Great forecasts also warn leaders when they need to make major changes to avoid disaster, particularly as it relates to managing their costs. As the old adage goes, forewarned is forearmed - meaning that a forecast empowers organizations to take the right actions at the right time.

This was one of the principle conclusions of a study by research firm Gartner, which showed the various "cost anchors" that weigh down businesses. A staggering 87%, for example, suffered from poor visibility into their costs, which analysts said would be best addressed by a mixture of rolling forecasts, driver-based and zero-based budgeting.

"Most companies don't have a clear mechanism to flag when costs are likely to spiral out of control," the Gartner report says. "Cost leaders in this area operate from a forecast model that identifies cost headwinds and tailwinds, which can be assessed on a quarterly basis, and considers factors such as foreign exchange rates; selling, general and administrative (SG&A) costs; pricing; volume; and productivity."

Fast, flexible and forearming forecasts may sound like a bit of a mouthful, but it's what FP&A teams focus on when they want their work to achieve lasting impact.

Learn more about the benefits and tangible rewards of rolling forecasts - and 10 tips to make them happen - in the whitepaper, Let's Get Rolling: 10 Tips for Moving from Static Budgets to Rolling Forecasts.