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.

Henri Steenkamp

Henri Steenkamp

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.

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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The budget is going to be out of date the day after you complete it.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.

Accept Uncertainty

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.

Avoid Overanalyzing

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 companiesFollow him on Twitter and read his thoughts on his finance blog and South Africa blog.

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2 responses to “Missing Forecasts Is Better Than Making Bad Decisions”

  1. Dear Henri

    One of the directions of our business is Milk Plants. There are seasonality of business.

    I agree with You:
    -“No matter how much pressure you feel to hit forecasts, try not to make them more than twice a year”;
    -“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”

    But I’d like to add something.
    Bearing in mind the seasonality of business, for maximizing profit it’s very important to make timely short-term and long term financial decisions (including the preparation of financial resources). In Milk business it’s a period for purchasing “a big volume of Milk” from April to July.
    Without going into particulars, sometimes one week (as stated above – one week during a period from April to July) through timely Milk purchase (reservation for purchase) might make entire annual profit.

    For this purpose we make two scenarios of budget:
    -“earlier” – if we shall be to have earlier financing for Milk purchase;
    -“later” – later financing.

    Budget with scenarios is ready and approved in December of previous year (according to our internal procedures).

    Therefore I’m ready (as CFO) in advance to ensure the maximization of profit:
    -in advance to hold negotiation with Banks about financing, taking into account our scenarios for forthcoming Year;
    -in advance to hold negotiation with our suppliers;

    Best regards
    Ruslan

  2. You raise many good points. But one fundamental question a CFO need to ask is “Are we planning our business or are we forecasting it?” Planning is about understanding where you are today, where you want to go, how to get there, and making course adjustments along the way to make sure you arrive where you want to be. Forecasting, on the other hand, is about trying to predict what might happen. Forecasts are often wrong (just ask the your local weatherman) while Planning can drive business success.

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