This article will describe the importance of forecasting and how it differs from budgeting.
Why is forecasting a good practice for all organizations? Here are five reasons:
- A forecast is usually a much quicker process and involves fewer employees.
- Forecasts, in general, are entered at the general ledger account level, while detailed templates, such as personnel templates, are not used.
- A budget is a company’s intention for the coming year, while a forecast is the most up-to-date expectation of what will happen over the remaining months of the year.
- The budget is finalized prior to the start of the year while a forecast can be created monthly or quarterly once the year has started and actual data can be reviewed.
- Many organizations create multi-year forecasts while budgets are only for the coming year.
While the budget is created one to two months before the year starts, the bulk of it is created up to fourteen months prior to the start of the month. For example, the budget is finalized in November for a company based on a calendar fiscal year, which is a year prior until the next November happens. Meanwhile, a lot can change in the various aspects of an organization regarding economy, industry, products, competitors, employees, and leadership. A forecast can more accurately consider this, thus influencing decision-making.
Companies can impact their bottom line by forecasting on a regular basis. An organization will be much more agile by forecasting monthly, as it can affect the following decisions:
- Expense reduction and tightening up the authority to spend money.
- Employee raises, new hires, and terminations.
- Capital expenditures reductions or increases.
- Strategic planning and modifying initiatives.
A forecast should include the current year actual data for the closed months and then allow the departmental managers to modify the amounts for the remaining months. Additionally, copying the budget data to the forecast will allow managers to concentrate solely on changes in the forecast. Another option is to show the prior year actual data as well.
Another example is a rolling forecast. This template type exists for organizations that do not create a budget but forecast monthly. Additional options, such as building a five-year forecast, are available as well. For a five-year forecast, it is recommended to forecast the first two years by quarter and the last three years annually, as it will be very difficult to estimate monthly past the first year unless the company’s revenue and expenses are very predictable.
One other option well suited for a monthly forecast is to enter an expected annual amount by each account. Then create a calculation that subtracts the annual amount entered from the actual year-to-date data and allocate the remaining amount. Allocate this amount based on historical actual data.
Finally, we recommend using the Breakback template. In the example below, The Breakback template allows a manager to enter a few amounts to create the forecast in October, November, and December:
- The desired net Income of $600,000. This is the main driver of the Breakback template and the only input that is mandatory.
- Increase all administration expenses by 3%. All of the departments are available for a global increase or decrease across all accounts.
- Increase administration full-time salaries by 6%. All of the accounts are available for a global increase or decrease across all accounts.
The calculation of a variance is the difference between the actual expenses and the budget, the actual expenses and the prior-year expenses, or the actual expenses and the forecast. To calculate revenue data, subtract the budget from actual expenses. To calculate expenses, simply do the opposite. The reason for this is that a positive variance is typically good while a negative variance is typically bad. Ask your staff why variances should be calculated and why they should analyze the variances. The first step is to calculate variances and allow departmental managers to enter comments to document the reasons for the variances.
Variance reports can have comparison reports against the budget for both month-to-date and year-to-date data. Envision a middle section that allows for comments, and conditional formatting for quickly highlighting variances in need of review. Variance reports can also be an exception report that allows the manager to filter out variances over or under a specific percentage so that the largest variances can be reviewed.
While there are several ways of showing variances, how management will create actionable items to prevent or correct the issues remains essential. Simply going through the variance process and documenting reasons as an exercise, such as holding the same meetings and entering the same comments, will render the analysis moot. Analyzing variances can help highlight trends, opportunities, issues, and successes. Variances should be a precursor to a reforecast, which can significantly affect hiring decisions, marketing spending, and strategy changes.
Below are a few best-practice recommendations on variance reporting and analysis processes:
- Provide variance reports to each department manager.
- The finance department should meet with each department manager to review the variances and discuss any concerns and successes.
- Build an input form that stores comments for all departmental material variances.
- Concentrate on the larger variances and discuss with the executive management of the company.
- Determine if changes need to be made to the strategy and initiatives of the organization.
- Continually reforecast and make decisions regarding the forecast. Once a forecast is created, then the variance reports should be off of the forecast first and the budget second.
- Document the action items and review them at the start of the next meeting.
Companies utilize forecasting to resolve how to allocate their budgets or plan for anticipated expenses for the upcoming year. Take the time to forecast and use the tips mentioned above to help achieve those organizational goals without wasting any time. If you need assistance or help, Solver has a team of experienced professional that can get your organization starting in building the right template for you.
Solver enables world-class decisions with BI360, a leading web-based CPM suite made up of budgeting, reporting, dashboards, and data warehousing, delivered through a web portal. Solver offers BI360 through cloud and on-premise deployment and is reinventing CPM with its next generation solution. BI360 empowers business users with modern features including innovative use of Excel in the model design process. If you’re interested in learning more, our team is excited to hear about your organizational needs and goals