Measure of the month: How far away are your sales forecasts?
Sales forecasting is a discipline that any strong finance team will want to master. This is especially important in industries where the majority of operating costs are fixed. When reliable and accurate, sales forecasts can help executives manage staff levels, production schedules, capital expenditures, and other business activities with greater confidence.
While some financial executives may dispute the merits of the traditional budgeting and corporate budgeting process, few would dispute the value of an accurate forecast. And I can tell you from experience that as of March 2020 (the start of COVID-19 lockdowns in the United States), most of my time as CFO has been spent forecasting and re-reviewing. sales, income and cash reserves. Completing this work allowed me to keep the Board of Directors informed, the management team focused and the employees reassured about our strong financial position.
To assess forecast accuracy, consider comparing your organization’s total sales forecast error percentage to the error percentage of similar-sized businesses in the same industry. Thanks to his Benchmarking of open standards Assessment in planning and management accounting, the APQC finds that the best performers have a forecast error of 1.1% or less. In comparison, the underperformers see more than twice the error rate at 2.7% or more. For an organization with $ 5 billion in revenue, the difference between top and bottom performance is $ 80 million in expected but unrealized sales.
Inaccurate forecasts can have devastating ripple effects. For example, drugs cannot sit on a shelf indefinitely if a pharmaceutical company’s sales forecast exceeds actual demand. And while many organizations in other industries would be happy to see demand exceed expectations, it can be a double-edged sword in an industry like pharmacy, especially if the organization cannot meet demand. demand for a product that saves lives. The effects may be more pronounced in some industries than in others, but increasing the accuracy of sales forecasts is worth it for any business.
Developing an accurate forecast requires integrated data and company-wide participation. The following practices have helped me and CFOs in many other organizations to produce more effective and accurate sales forecasts.
Aim for integrated data
One of the first and most important steps is to identify the information you need to prepare a forecast and ensure that you have access to that information. System reports, historical data, and even employee observations are essential to producing a complete forecast.
Unfortunately, data silos and disparate systems present barriers. For example, only 14% of respondents to APQC’s Open Standards Benchmarking assessment of management planning and accounting indicate that operational and financial data is housed in a single integrated solution.
Collecting and reconciling data from disparate systems not only takes longer, but makes errors more likely. In contrast, companies can make big gains in forecasting accuracy by adopting integrated cloud-based solutions, as well as automation and machine learning. For example, a finance manager at a global tech company told us that adopting machine learning and integrating organizational data has halved the error rate.
A culture of reliable forecasting
Targets are the goals that organizations set for themselves, while forecasts attempt to predict where management thinks results are really heading. Ideally, organizations will develop action plans to close any gaps between forecasts and targets. However, when organizations attach a bonus or other rewards to forecasting accuracy, it can easily lead to a situation where employees forecast conservative net income that minimizes revenue expectations and maximizes future expenses, as long as the net total is acceptable. While viewed as prudent from a financial management perspective, this approach results in constant minimization of opportunities and timid approaches to growth.
Rather than encouraging precision, it is better to focus a team on presenting unbiased and reliable information. There can be reliability and usefulness metrics for forecasts that are aligned with strategic goals without the need for financial incentives based on accuracy. This can be achieved, for example, by rewarding relative performance or improvement. This approach shifts the motivation from forecasting to making the best and most realistic estimates rather than manipulating forecasts to improve the appearance of results.
Rolling driver-based forecasts can also indirectly facilitate accuracy and discourage employees from playing on the forecast. A rolling factor-based forecast updates key financial performance drivers on a rolling basis, typically quarterly for the next five quarters. As the rolling forecast extends beyond the period / end of the year, strategic conversations are less about assessing performance and more about future performance and how to get there.
Integrate stakeholder comments
Working together to create forecasts increases the likelihood that actual results for future periods will align with forecasts produced today. Forecasts not only benefit from comprehensive quantitative data, but also qualitative information gathered from across the enterprise. For example, sales may know of the existence of new products that may cannibalize demand for old products, while manufacturing may provide information on downtime that will impact supply.
When stakeholders help build the forecast, these forms of implicit knowledge are made explicit and become part of the forecast. This not only helps improve forecasting accuracy, but also creates greater buy-in for forecasts and the plans that result from them.
Even with stable costs, a two point or even one point percentage error in a forecast is significant. And forecasting is the foundation for a wide range of planning processes, from financial planning to strategic planning and beyond. For both of these reasons, it’s worth spending the time and resources to integrate the data, focus the team on developing a reliable forecast, and integrate feedback and ideas from across the board. company.
Perry D. Wiggins, CPA, is Chief Financial Officer, Secretary and Treasurer of APQC, a Houston-based nonprofit benchmarking and best practice research organization.