Any CFO will tell you that forecasting is one of their most critical tasks. For both public and privately traded companies, an incorrect forecast and misaligned results can lead to a tumbling stock price or seriously frustrated investors. Accurate forecasting won’t just affect your finance department – it’ll affect the running of your entire organization.
Getting your forecasting right is crucial. That means being careful in the detail you go to, the people you involve, and involving market data. It could also mean integrating revenue planning software or switching to a rolling forecast.
What is a Revenue Forecast?
A revenue forecast is a calculated estimation of a company’s future revenue over a certain length of time. Revenue forecasts are usually made monthly, quarterly, or annually.
For CFOs, revenue forecasting is a vital tool for all parts of the business. Not only does it inform priorities and how the organization is structured, it helps prepare for potential fluctuations in the market over the coming months or years.
A revenue forecast informs decisions in the following key areas:
Setting realistic sales targets
Budgeting for expenses
Identifying potential financial risks and opportunities
Allocating resources effectively
Managing cash flow
Revenue forecasts are now predominantly created in part or wholly by using specialized forecasting software.
What Are the Different Methods of Revenue Forecasting?
Revenue forecasts are typically made using one or more of the following methods, each with different levels of complexity and utilisations. Let’s quickly run through each of them.
Moving average forecasting: a complete average of numbers, like revenue, from a single time period.
Straight-line forecasting: a forecast based on a continuation of the growth trend from a single time period.
Time series forecasting: identifying external data patterns to create a forecast based around these trends.
Linear regression forecast: using predictive analysis to create a trend line that forecasts revenue based on a set of historical data points.
How Do You Create a Revenue Forecast?
Let’s break down how to make a revenue forecast step-by-step.
Start by defining the “timeline” – that is, the length of the period that you want to forecast for. The length should be set by the initial objective of the forecast project, like predicting a quarter’s worth of data to inform a quarterly sales target.
Using relevant historical data, identify your own fixed and variable costs. Then creating a forecast of your own sales. Consider how external affects such as seasonality, trends determined by your previous performance, competitors and how the behaviour of the market may affect performance.
Combine the sales forecast with the affects of external factors to create your initial forecast. Validate the forecast by testing it in different positive or negative scenarios and by checking it against key financial ratios.
How You Can Improve a Revenue Forecast
Once you’ve chosen from a selection of financial forecasting approaches, you may decide to find ways to improve your forecast. This could involve improving its overall accuracy or incorporating additional data to make the forecast more nuanced. Some core methods for improving forecasting include:
Increase the Accuracy and Detail of your Data
A simple way to improve a forecast is by ensuring that your data is accurate, and that you prescribe the right level of detail in the right areas. Specifically, aim for high accuracy in the datasets that are key to your business performance and forecast. Vet and scrutinise data to ensure your sources are correct.
On the other hand, don’t drill down to the same level of detail for the areas that aren’t as critical to you. This allows you to improve the efficiency of your forecasting process while maintaining or increasing accuracy.
Include Only Relevant Teams and Stakeholders
Revenue forecasts are often collaborative projects but, as many CFOs know, including too many people can amount to unnecessary time and resource costs. Consult only those with crucial knowledge from different teams, creating a streamlined process that still draws information around company operations, sales, or customer behavior.
Utilize Advanced Analytics Software
With modern forecasting being primarily undertaken using software, one key measure you can take to improve your forecasts is to upgrade the software you use. Different FP&A Software programs provide different levels of complexity. Choosing the correct software tool for your goals, and to synthesize with the systems your organization uses, is an effective way to improve your overall forecasting capabilities.
Update the Forecast Regularly
The accuracy of your forecast depends, to a large extent, on the initial data used to create your model. By regularly revisiting the assumptions you made and updating your forecasting with fresh datapoints, you can maintain the accuracy of your forecast to your current performance. You can even take it a step further by implementing a rolling forecast.
What is a Rolling Forecast?
A rolling forecast is a continually updated forecast, fed and updated with new and often real-time data. Rather than a forecast with a fixed end or expiry date, rolling forecasts are extended using new data while accounting for changes in the market or within the organisation itself.
When used to inform budgeting or sales and revenue targets, the freshness and improved accuracy of a rolling forecast can help with amending or tailoring these set numbers to ensure they are not outdated versus the current financial position of the business.
How is a Rolling Forecast Different to a Revenue Forecast?
There are a few big differences between a standard revenue forecast and a rolling forecast, many of which can also be considered advantages to using the latter.
Rolling forecasts don’t expire. One-time revenue forecasts often face the problem of becoming out of date, especially if there are large shifts in the business or in the market. A rolling forecast, updated continually using the data from these shifts, amends the forecast appropriately to any changes and allows CFOs and financial stakeholders to make informed decisions based on updated data.
Set more accurate goals. Similarly, the ability to adjust forecasted performance based on fresh data allows teams to realign their current goals or even set new, more attainable targets. Better goal setting can result in improved analytics around the performance of your teams and business and help to better determine where resources are best allocated.
When Should You Use a Rolling Forecast Instead?
Very simply, a rolling forecast should be adopted when you find your business needing to regularly make new forecasts or adjustments to your budgets or goals based on significant shifts to internal or external conditions. Rather than continually making new revenue forecasts, a rolling approach allows continual adjustments to be made to a single forecast.
What are the Differences When Creating a Rolling Forecast?
There are fundamental similarities to the process of making a standard revenue or rolling forecast. Both require you to:
Set initial objectives and a timeline for the forecast.
Involve chosen contributors.
Identify your assumed fixed and variable costs, predict sales, and model potential market influences or customer behaviour.
While you will set a timeline, you also need to decide on a “horizon” for your rolling forecast. It is not sensible to have it continually rolling, as underlying assumptions that inform its creation may change, so you’ll need to decide on a limit to when your rolling forecast will be discontinued or recreated.
Once your rolling forecast is created, it has a greater ability to provide modelling for different scenarios. Create your “base case” forecast, and then set up models for different scenarios.
Once your rolling forecast has begun, you should regularly compare actual performance to forecasted performance. Termed as “Budget vs Actual”, this pits the two numbers against each other to identify variances which can be analyzed. These variances can then be adapted into the model to make amendments to the forecast itself.
Conclusion
Revenue or rolling forecasts are essential tools for CFOs. Their widespread benefits in setting realistic targets and budgets, as well as identifying fluctuations, help to create financial stability and even growth.
While a static forecast is a good baseline for effective financial management, a rolling forecast allows for improved variance analysis and adaptive modelling that is essential in the fast-moving, dynamic markets of the modern financial world.
Using financial planning software is essential for creating accurate forecasts – and can often be the difference maker for CFOs who want to set up their business for success.
