No one is immune to the challenge of building business forecasts – whether it’s first-time entrepreneurs or large businesses. Whether it’s for the Board, or for a bank, or for prospective investors, forecasting is a large chunk of the finance function and the sales function. Depending on the size of your company, building business forecasts may be a single person’s task, a multi-function effort or a task that is outsourced to experts. Whatever the case may be, there is always scope for error.
So what are the most common rookie mistakes we see when we evaluate companies’ financial forecasts?
Not consulting functional teams
Creating financial forecasts usually falls in the able hands of the finance team. Finance teams, however, often make the mistake of not consulting their peers in other functions. At the risk of stating the obvious, you cannot build sales forecasts without having an in-depth meeting with the sales team.
Creating a static forecast
A static forecast is one where it’s all numbers and very little flexibility. Hard-coding instead of using formulas, making changes inside cells rather than via formula, back-working portions of a P&L to arrive at a desired profit figure are all examples of this. The result is usually a forecast that is of limited use, has low reliability and is confusing to others. Remember: it’s no good if the only person who fully understands it is the person who made it.
Expecting the future to mirror the past
Having grown 10% year-on-year for the last three years is no indication that the company will continue to grow at 10% for the next three years. Low debtor defaults last year don’t imply low defaults next year. Start again, re-assess all the critical aspects of your business and most importantly, widen your view beyond the financials. New developments in the sector, changes in customer profile and changes in regulations could all impact your forecasts substantially.
Confusing “targets” with “forecasts”
It’s tacitly understood that a target is what a company would like to achieve. A forecast is meant to be a closer reflection of what the company will actually achieve. Unfortunately, most companies’ personnel use them differently, and end up under- or over-committing. There are those who believe the targets will always be met and there are those who believe targets are made simply to “motivate” sales teams and for no other reason. Unsurprisingly in both cases, top management’s view of their teams’ budgeting accuracy suffers.
Teams often also commit to unreasonable growth targets when faced with new situations, such as fund-raising. Result? You may raise funds successfully but will definitely struggle to meet IRR targets or interest payments in future. This is the forecasting equivalent of winning the battle and losing the war.
In Part 2 next week, we’ll look at a few “best practice” approaches to creating reliable business forecasts.
Update: Part 2 is now up – read here.