Sales forecasting is a discipline that any strong finance team will want to master. It’s especially important in industries where the majority of operating costs are fixed. When it’s reliable and accurate, the sales forecast can help leaders manage staffing levels, production schedules, capital expenditures, and other business activities with greater confidence.
While some finance leaders may argue against the merits of the traditional budget and the corporate budgeting process, not many would argue against the value of an accurate forecast. And I can tell you from experience that beginning in March 2020 (the onset of COVID-19 lockdowns in the United States), most of my time as CFO was spent forecasting and re-forecasting sales, revenue, and cash reserves. Performing this work allowed me to keep the board of directors informed, the leadership team focused, and employees reassured of our strong financial position.
As a step toward assessing forecast accuracy, consider benchmarking your organization’s total sales forecasting percentage error against the percentage error of similar-size companies in the same industry. Through its Open Standards Benchmarking assessment in planning and management accounting, APQC finds that top performers have a forecasting error of 1.1% or less. In comparison, bottom performers see more than twice the rate of error at 2.7% or more. For an organization with $5 billion in revenue, the difference between top and bottom performance amounts to $80 million in expected but unrealized sales.
Inaccurate forecasts can have devastating ripple effects. For example, medicines 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 outstrip a forecast, it can be a double-edged sword in an industry like pharmaceuticals — especially if the organization can’t meet the demand for a life-saving product. The effects might be more pronounced in some industries than others, but increasing sales forecast accuracy is well worth it for any company.
Building an accurate forecast requires integrated data and enterprise-wide participation. The following practices have helped me and CFOs across many other organizations to produce more efficient and accurate sales forecasts.
One of the first and most important steps is to identify the information needed to prepare a forecast and ensure that you will have access to that information. System reports, historical data, and even employee observations are key to producing a comprehensive forecast.
Unfortunately, data silos and disparate systems present barriers. For example, only 14% of respondents to APQC’s Open Standards Benchmarking assessment in planning and management accounting report that operational and finance data is housed in a single, integrated solution.
Gathering and reconciling data from disparate systems not only takes longer but makes errors more likely. By contrast, organizations can make big gains in forecast accuracy by adopting integrated cloud-based solutions along with automation and machine learning. For example, one finance lead at a global technology company told us that adopting machine learning and integrating the organization’s data helped to cut the error rate in half.
Targets are the goals that organizations set, while forecasts try to predict where management thinks results are actually headed. Ideally, organizations will develop action plans to close any gaps between the forecast and the targets. However, when organizations attach a bonus or other rewards to forecast accuracy, it can easily lead to a situation in which employees forecast a conservative net income that minimizes revenue expectations and maximizes future expenses, so long as the net total is acceptable. While considered prudent from a financial management point of view, this approach results in constant minimizations of opportunities and timid approaches to growth.
Rather than incentivizing accuracy, it’s best to focus a team on presenting unbiased, reliable information. There can be measures of reliability and usefulness for the forecast that are aligned with strategic objectives without the need for accuracy-based financial incentives. This can be achieved, for example, by rewarding relative performance or improvement. This approach shifts the motivation of the forecast toward making the best, most realistic estimates rather than manipulating the forecast to make the results look better.
Driver-based rolling forecasts can also indirectly facilitate accuracy and discourage employees from gaming the forecast. A driver-based rolling forecast updates key drivers of financial performance on a rolling basis, typically quarterly for the next five quarters. Because the rolling forecast extends beyond the period/year-end, strategic conversations become less about performance evaluation and more about future performance and how to get there.
Collaborating to create the forecast makes it more likely that the actual results in future periods will be aligned to the forecast produced today. Forecasts not only benefit from complete quantitative data but also qualitative insights gathered from across the enterprise. For example, sales might know about new products that will likely cannibalize demand for old products, while manufacturing can provide insight on downtimes that will impact supply.
When stakeholders help build the forecast, these forms of implicit knowledge are made explicit and become part of the forecast. That not only helps to improve forecast accuracy but also helps drive greater buy-in for the forecast and the plans that come from it.
Even with costs remaining stable, a two-point or even one-point percentage error in a forecast is significant. And forecasting is foundational to a wide range of planning processes, from financial planning to strategic planning and beyond. For those two reasons, it’s worth it to expend the time and resources needed to integrate the data, focus the team on developing a reliable forecast, and incorporate feedback and insights from across the enterprise.
Perry D. Wiggins, CPA, is CFO, secretary, and treasurer for APQC, a nonprofit benchmarking and best practices research organization based in Houston.