It can be tempting for CFOs to overly look to forecasts when pressed to make important financial decisions. After all, projects based on new information can change budgets substantially in real time.
However, a CFO should not react to every short-term event or change to the numbers. Making snap decisions based on perceived pressure to hit forecasted numbers is almost never a good idea. In fact, reacting to forecast pressure can be a CFO’s Enemy #1.
For that reason, CFOs should exhibit care to separate actual budget activities from forecasts. This will allow them to effectively make accurate and informed financial decisions, and save time along the way.
Here are some ways to stop giving in to forecasting pressure so that financial planning efforts are more effective:
Don’t Update Forecasts Daily
To get accurate results on a meal plan, a nutritionist will tell you not to weigh yourself every day. The act of obsessing over each reading of the scale will only reap anxiety and won’t likely have a positive impact on results.
While it’s important to revise a forecast if a major project is under way and affecting bottom-line financials, it’s generally not a good idea to update the forecast every day or week to accommodate every change. Doing that means you’re trying to force those numbers to become a reality. There may be pressure from the board to see such numbers, and the CEO may want to have a good idea what is going to happen next year based on current conditions, but it is not realistic to work with ever-changing numbers.
The budget is going to be out of date the day after you complete it. That’s just reality. But short-term events and trends are always less instructive than averages over longer time periods. Life isn’t linear, and there are going to be some lumps and bumps to consider.
No matter how much pressure you feel to hit forecasts, try not to make them more than twice a year. Quarterly information is like annualization: It may not take into account the entire picture.
Forecasts are less about measuring the present against the past and reacting to daily events, and more about anticipating the future while factoring in current conditions.
There are always elements of uncertainty and risk associated with your operations. Managers must be aware of that and simply accept it, instead of trying to avoid it or compensate for it.
Accepting uncertainty means taking the pressure of producing completely accurate forecasts off the CFO’s shoulders. A forecast is only as good as the inputs and variables used, and actual results often vary from those assumptions. There must be room for the possibility of changing conditions along the way.
Another common mistake CFOs make is spending too much time analyzing data — and doing it too frequently. Analysts may, for example, annualize the previous quarter’s numbers for use as a 12-month metric. They may multiply a quarterly number by four and call it the return on equity.
A midsized or small company may be very sensitive to individual events, so using such annualizations is misleading. Using trailing 12-month (TTM) numbers is more accurate, as it factors in one-off or non-recurring events but does not overstate them or assume they will occur every quarter.
Don’t Reflect in Real Time
It’s easy to get into the habit of forecasting in real time, drawing conclusions about what is and isn’t working. But that’s not logical. Remember, you existing forecast was based in part on some assumptions. Just because something unexpected happened, it doesn’t invalidate your original assumptions. Given market volatility and factors outside your control, the future could look different from both your original forecast and subsequent ones. Give things more time to play out.
In summary, it’s important not to turn forecasting reports into actual working budgets, to limit forecasts to a small few per year, and to refrain from overanalyzing any short-term data. It is critical to a company’s success.
Henri Steenkamp is CFO of Saratoga Investment Corp., a provider of financial solutions to middle-market companies. Follow him on Twitter and read his thoughts on his finance blog and South Africa blog.