Proper Use of Rolling Forecasts in Contemporary FP&A
Updated: Nov 16, 2022
Most companies manage corporate performance through a budgeting and planning process. This process produces a standard of performance by which sales, operations, shared service areas, etc., are measured. It is executed via the following sequence:
Create a forecast with specific performance targets (revenue, expenses).
Track actual performance against targets (budget to actual variance analysis).
Analyze and course correct.
Despite the simplicity of this sequence, creating an accurate financial plan can be a challenge for most FP&A teams. In the past, a forecasting team would undertake the grueling process of multiple all-nighters to make a deadline, grinding through spreadsheets, calculating growth percentages, chasing down anomalies, etc. etc. Despite their best efforts, biases, and guesswork, human errors would creep into their results.
What makes this circumstance in FP&A today different from the financial planning process just described is access to high tech resources, and more sophisticated rolling forecast methods. In order to maximize the results of their financial plans, FP&A professionals must be aware of the best practices in forecasting and budgeting, and specifically, what that means in a high tech world.
Traditional/Static Budget Pros & Cons
Static budgeting is the more basic strategy in financial planning. Typically, it involves a one-year forecast of revenue and expenses down to net income. It is built from the “bottom up,” which means that individual business units supply their own forecasts for revenue and expenses, and those forecasts are consolidated with corporate overhead, financing and capital allocations to create a full picture.
The static budget is the pen-to-paper filling out of the next year in a company’s strategic plan, usually a 3-5 year view of where management wants consolidated revenue and net income to be, and which products and services should drive growth and investment over the coming years. In general, the two purposes of a budget are: 1. Clarifying resource allocation, and 2. Providing feedback for strategic decisions.
Despite the straightforwardness of the traditional budgeting process, there are two critical disadvantages when using this method.
The traditional budget does not react to what is actually happening in the business during the forecast: Creating a fixed budget can take up to 6 months at large organizations. This requires business units to guess about their performance and budget requirements up to 18 months in advance. Therefore, the budget may be inappropriate to the company’s financial situation almost as soon as it’s released, and becomes more irrelevant with each passing month.
The traditional budget creates a variety of perverse incentives at the business-unit level: A sales manager is incentivized to provide overly conservative sales forecasts if he or she knows the forecasts will be used as a target, as they benefit from under promising, and over delivering. These kinds of biases reduce the accuracy of the forecast, which management needs in order to get an accurate picture of how the business is expected to fare.
Rolling forecasting is a more dynamic approach to budgeting, which manages to create a financial forecast without the disadvantages of a fixed budget.
Rolling Forecasting as a Solution to Fixed Budgeting's Shortcomings
The rolling forecast involves a re-calibration of forecasts and resource allocation every month or quarter based on what actually happens in the business.
Making resource decisions as close to real time as possible can funnel resources more efficiently to where they are needed most. It provides managers with a timely vision into the next twelve months at any given point in the year. Additionally, a more frequent, reality-tested approach to target setting keeps everyone more honest, and eliminates the biases elicited by some sales managers during the traditional budgeting process.
However, there is a considerable disadvantage in rolling forecasting; it is high maintenance. A fixed budget, in comparison to a rolling forecast, can be much less of a headache in this respect. Traditional budgets require much less time and manpower that is needed throughout the rolling forecast process.
Best Practices in Rolling Forecasting
In order to practice a quality rolling forecast consistently, there are a number of actions that organizations must execute prior to the plan’s implementation. The steps are as follows:
Ensure Alignment and Collaboration: Ensure that the management and entire team are on board with the new practice, across different business units.
Hire Talent/Reskill Workers: You need experienced finance professionals with the appropriate technical skills to make a rolling forecasting strategy work. Implementing a rolling forecast strategy may entail hiring new people, or reskilling current employees.
Use the Best Software Systems: Having supporting systems in place is essential. Ideally, data flows into the forecast automatically. And once you create a baseline forecast, you’ve only just started. Additional analysis and constant updates are the whole point, and that typically stresses spreadsheets beyond their best use. Organizations can improve their budgeting and forecasting even more by using software which complements spreadsheet usage.
Ensure Quality Data: Rolling forecasts are only as good as the data they use. This methodology requires frequent imports of actuals — metrics like labor rate, purchase price and selling price — into the models for variance analysis to ensure things are on track. Forecasts based on drivers and real-time assumptions are more likely to be actionable. By integrating actuals with forecasts, organizations can identify issues early and refocus priorities and resources as necessary.
Conclusion
Accuracy and efficiency are two of the greatest challenges FP&A professionals face in the financial planning process. Both of them can be improved through a more dynamic planning process, and the use of the best high tech resources financial software has to offer.