Do you need a crystal ball to create a forecasting model?

Forecasting can help your business set achievable goals. But where do you start? By creating your budget. Forecasting models and budgeting are not the same. Budgets are what you want to happen, while forecasts reflect what you think will happen.

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No, you just need to know where to start.

Forecasting can help your business set achievable goals. But where do you start? By creating your budget.

Forecasting models and budgeting are not the same. Budgets are what you want to happen, while forecasts reflect what you think will happen.

A budget is a static plan that covers a specific period and is usually based on the company’s past trends. A forecasting model is a dynamic projection based on historical results, economic impacts, and operational changes that occur throughout the year. Forecasting looks at the company's current financial situation and uses that information to predict whether or not a budget will be met.

Budget first, then forecast.

A budget is the projected revenue and expenses of a business for a given period, usually one year. Once the budget is finalized, it generally isn’t modified.

Budgeting may sound simple, but there are a number of approaches you can use. Each method has pros and cons, and whichever approach you take should be based on what will be most accurate and impactful in projecting the financial outcomes of the business.

Incremental budgeting. This is one of the most common approaches. This method starts with the prior year actuals and layers in the assumptions for the upcoming year.

Zero-based budgeting. A zero based budget starts from scratch, not by using actual expenses incurred in a previous year. If an expense is not justified or approved, it is eliminated from the budget. A zero-based budget can be more time consuming but it is ideal for decreasing costs.

Value proposition budgeting. This budget plans expenses based on the value it will bring to the company.  This method could be used in government spending, allocating funds based on the services that are most needed. The end goal of value proposition budgeting is to spend more on expenses that are more valuable to customers, which in turn should result in an increase in revenue.

“Rolling” budgeting. This budgeting approach is continuously updated. When one month is completed, another month is added to the end of the budget to maintain the desired number of months the business would like to have in a budget at any given time.

The best practice in budgeting is to not change the budget once it is set. This will allow the business to assess the accuracy of the original budgeting assumptions.

However, goals may become unattainable if significant changes occur during the year. At this point, you will definitely need to create a forecasting model to fully understand where the business is headed in order to make the appropriate decisions.

Now it’s time to do your forecasting model.

Creating a forecasting model is a more dynamic process than creating a budget. As the year progresses, a forecast model generally becomes a more accurate representation of the trajectory of the business because it’s continually updated based on actual results and changes.

For example, if the budget included a significant client that departs during the year, the forecast would have to be modified to remove the revenue from that client. But the original budget would not change. By factoring this revenue loss into the forecast, a business owner will be better able to see the impact that this loss will have on the projected results and can make changes in expenses or other areas of the business to mitigate the losses.

Understanding discrepancies between the forecast, the budget, and actuals, which can either be expenses or revenue, can help determine a realistic growth target.

How to create a forecasting model.

There are different ways to develop an accurate, efficient forecasting process.  Start with the budget, as that will be the most accurate initial projection of the growth target for the business at the beginning of the year.

Realistic assumptions should be built into the forecasting models to ensure the growth potential is achievable and decisions are being driven by accurate models.  

Once actuals are incurred, compare them to the budget and determine if the variances are actual variances or timing variances.

A timing variance will be resolved in a future month. For example, if a project was budgeted to start in one month but was delayed, you’d see a variance in the month it was budgeted as well as in the month it actually happened. These variances would offset assuming the project continued to completion, but the month it happened would differ from when it was budgeted.

An actual variance would occur if the budgeted projected was canceled.

You would need to update future month revenue and expenses in the forecasting model based on any timing and actual differences. Determine what changes need to be made to achieve the planned growth targets established during the budgeting process.

Software to make the process more efficient and cost effective.

To make forecasting easier, you can rely on a range of tools such as:

  • Microsoft®Excel® models
  • CRM software like:
  • Salesforce
  • Monday Sales CRM
  • Microsoft Dynamics

Forecasting software such as:

  • Cube
  • Workday Adaptive Planning
  • Anaplan
  • Oracle Hyperion
  • IBM Planning Analytics with Watson

Forecast models help determine what happens to your business when your budget projections aren’t met.

Maintaining a forecast model is critical in determining whether growth targets are achievable when the actual results differ from the budget during the year. This allows you to make real-time adjustments to your projections. That helps you understand where changes may need to be made to achieve business goals or pivot to a new strategy.

If a budget was created with an unrealistic revenue target, the forecast can be adjusted to update revenue target and determine what changes are needed in the expense projections to achieve the desired growth.

Let’s say a business owner gives employees raises based on aggressive revenue projections. But shortly into the year, a key client goes out of business, significantly impacting the revenue projection for the year. A forecast model can help determine the impact unforeseen circumstance will have on the business and allow you to map out different scenarios to maintain expenditures such as raises, decrease other variable costs, and achieve a realistic goal despite the decline in revenue.

An effective budgeting strategy is to create revenue projections that are realistic and conservative, with expenses budgeted to support the revenue. If revenue does not reach budgeted goals, use the forecast model to identify expenses that can be reduced in the forecast. On the other hand, if revenue exceeds budgeted goals, a forecast model can help you assess if expenses can be increased to support additional growth while maintaining original margin projections.

Maintaining a forecast and identifying variances to actual will allow a business owner to react quickly and determine attainable growth targets.

How to effectively update a forecast model to ensure achievable growth targets.

The ability to identify the variances between budget, forecast, and actuals will prove beneficial when you’re trying to look ahead.

If a business is experiencing favorable revenue variances, they may need to consider hiring more or increasing operational costs to accommodate the growth.

Expense variances should be reviewed and understood to ensure timing or actual, and if changes are needed to either increase or decrease those costs.

Referring to the original budget will help drive decisions toward the original growth target. Having an accurate revenue forecast will drive the expense forecasting process to ensure growth targets are achieved. By updating and maintaining the forecast model, you’re able to identify changes that need to be made to achieve the growth targets when variances occur.

The importance of accurate data for a forecast.

The forecast will only be as accurate as the data you put into the forecasting model.

Establishing a solid month-end close process with policies and procedures in place will ensure that the actual financial information is accurate and can be relied upon to make future decisions.

Data used for the forecast model should be based on sales projections, including existing clients and new clients in the sales pipeline. Cost of sales will be projected based on expenses needed to support those sales projections. Administrative costs are generally fixed, based on prior month actuals or knowledge of administrative needs to support the pipeline. The data should also be based on prior month actuals, new client contracts being signed, and a solid understanding of the expenses needed to support additional revenue.

Forecasting models can help create achievable growth goals.

Developing an accurate forecasting model will have many benefits to setting achievable growth goals for your business.

Creating a realistic, manageable budget, understanding variances as they appear — what caused them and what they represent to progress towards your financial goals — and then being able to update your forecast based on changes all contribute to achieving your growth goals.

Accountinuity can help you build your best approach to forecasting.

We work closely with business owners to develop budgets and maintain accurate forecasts throughout the year. Our team reviews variances between budget, forecast, and actual results, and works with the business owner to ensure they understand what changes need to be made to achieve the planned growth targets.

If you would like to know more about how we can help with budgeting and forecasting — or if you have questions — please contact us at hello@accountinuity.com. Spend an hour with our team of experts. No charge and no obligation.

Accountinuity is the financial and accounting team for growth-minded entrepreneurs seeking to profitably scale their business. We deliver complete flexibility for how businesses use our services and because we can manage every aspect of their accounting operations, they can focus on growing their business.


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