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How do you test your assumptions and projections?

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When you create a budget or a forecast, you need to make some assumptions and projections based on your past performance, market trends, and future goals. But how do you know if your assumptions and projections are realistic, accurate, and reliable? How do you test them to avoid surprises, errors, or missed opportunities? In this article, you will learn some methods and tips to test your assumptions and projections and improve your budgeting and forecasting skills.

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1 Use historical data

One of the simplest and most effective ways to test your assumptions and projections is to use historical data from your own business or industry. Historical data can help you validate your assumptions and projections by comparing them with actual results, identifying patterns and trends, and adjusting for seasonality and outliers. You can use historical data from different sources, such as financial statements, sales reports, customer feedback, and market research. You can also use historical data from different time periods, such as monthly, quarterly, or yearly, to see how your assumptions and projections change over time.

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Stephen Newland, CMA

Fractional CFO helping nonprofits unlock financial sustainability with clear + actionable insights
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One of the most effective analysis you can run on historical data to test your projections is a common size analysis. This is as simple as taking every line item & dividing it by a fixed line item. For example, on the P&L you would take every line item divided by total revenue. If you do this for last year's actuals next to your budget/forecast it will clearly highlight areas that are much higher/lower. If a line item is much higher/lower vs. actuals it could be a sign there's an issue with the forecast/budget. That's not always true, but if it's not explainable by a change in the business it's a good sign there's something to address!

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Meghan Trout

Business Operations Manager @ Employers Advantage LLC | HR Solutions
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Historical data is a cornerstone for our budgeting and forecasting. By analyzing past expenditures and project costs, we refine our financial planning. Last year’s data, for instance, helped us pinpoint precise budget allocations for upcoming engagements. Feedback from previous projects also shapes our pricing strategies. In essence, historical data not only validates our financial assumptions but also guides our growth strategy.

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2 Use sensitivity analysis

Another way to test your assumptions and projections is to use sensitivity analysis. Sensitivity analysis is a technique that allows you to measure how your budget or forecast changes when you vary one or more of your assumptions or projections. For example, you can test how your revenue or profit changes when you increase or decrease your sales volume, price, cost, or growth rate. Sensitivity analysis can help you assess the impact and risk of different scenarios, identify the key drivers and variables of your budget or forecast, and optimize your decision making.

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CA PRAJAKTTA GHATE ??

Finance R to R Lead | Financial Planning and Analysis |Managed 500+ facilities locations financials and proven efficient cost controlling | Ex-Credit Suisse | Ex-Capgemini |
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I definitely agree that using scenarios planning very extensively is important part of sensitivity analysis in testing the robustness of our budget or forecast. One point amongst many others which I would consider significant to mention here is that the purpose behind detailed analysis of the results of each scenario is to understand the range of potential outcomes which will help us to identify risks and opportunities associated with each scenario & to realize few may change the positions drastically. For example, we may discover that in the "worst-case" scenario, our organization could face a cash flow crisis, while the "best-case" scenario might highlight opportunities for expansion. so it's very significant tool in the overall process.

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Meghan Trout

Business Operations Manager @ Employers Advantage LLC | HR Solutions
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Sensitivity analysis is an invaluable tool in our budgeting toolkit. In the unpredictable realm of HR consulting, where client needs and market dynamics shift, this technique equips us with a ‘what-if’ perspective. By tweaking variables like projected client engagements, hourly rates, or operational costs, we can visualize potential revenue and profit scenarios. For instance, adjusting our growth rate or project costs offers insights into potential profitability thresholds. Sensitivity analysis not only helps gauge the robustness of our projections but also pinpoints the critical factors influencing our bottom line. It’s a strategic approach that enhances our decision-making, ensuring both financial stability and adaptability.

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3 Use benchmarks and standards

A third way to test your assumptions and projections is to use benchmarks and standards. Benchmarks and standards are external references that can help you evaluate your budget or forecast against the performance or expectations of others. For example, you can use benchmarks and standards from your competitors, peers, industry, or best practices. You can also use benchmarks and standards from your customers, suppliers, regulators, or investors. Benchmarks and standards can help you gauge your strengths and weaknesses, spot gaps and opportunities, and align your budget or forecast with your stakeholders' needs and goals.

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4 Use feedback and validation

A fourth way to test your assumptions and projections is to use feedback and validation. Feedback and validation are the inputs and opinions of others that can help you improve your budget or forecast. For example, you can use feedback and validation from your team members, managers, experts, or mentors. You can also use feedback and validation from your customers, partners, or advisors. Feedback and validation can help you challenge and refine your assumptions and projections, incorporate different perspectives and insights, and increase your confidence and credibility.

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5 Use software and tools

A fifth way to test your assumptions and projections is to use software and tools. Software and tools are the applications and systems that can help you automate, simplify, and enhance your budgeting and forecasting process. For example, you can use software and tools such as spreadsheets, dashboards, calculators, or simulators. You can also use software and tools such as analytics, artificial intelligence, or machine learning. Software and tools can help you perform calculations, generate reports, visualize data, and apply advanced methods and techniques.

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6 Use experiments and tests

A sixth way to test your assumptions and projections is to use experiments and tests. Experiments and tests are the actions and trials that can help you verify your budget or forecast in the real world. For example, you can use experiments and tests such as pilot projects, prototypes, or surveys. You can also use experiments and tests such as A/B testing, split testing, or multivariate testing. Experiments and tests can help you collect data, measure results, compare alternatives, and validate hypotheses.

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7 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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How do you test your assumptions and projections?

1

2

3

4

5

6

7

1 Use historical data

2 Use sensitivity analysis

3 Use benchmarks and standards

4 Use feedback and validation

5 Use software and tools

6 Use experiments and tests

7 Here’s what else to consider

Budgeting & Forecasting

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How do you test your assumptions and projections?

1

2

3

4

5

6

7

1 Use historical data

2 Use sensitivity analysis

3 Use benchmarks and standards

4 Use feedback and validation

5 Use software and tools

6 Use experiments and tests

7 Here’s what else to consider

Budgeting & Forecasting

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