5 Practical Steps To Increase Your Forecast Accuracy Today

How Can Businesses Forecast More Accurately?

In my previous article here I wrote about some important reasons why companies need to take forecast accuracy more seriously. That’s all well and good but where to start, and how can companies go about making improvements in a practical way? Well, the service industry in the UK accounts for 79% of total economic output and 83% of employment, so let’s start there.

Step 1 – Capture Business Drivers Appropriately

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I’ll take a broadly applicable example and focus on Expense Planning because most businesses can relate to this. ?From cleaners to accountants, most of the business drivers are the same. This is aside from big disparities around income drivers, which can be nuanced depending on the scale and complexity of the organisation in question, however we won’t tackle those today.?

Service businesses are not known to be particularly capital intensive, so we’re not expecting a bulging balance sheet, but we would expect to see large variable costs as part of the Operating Expenditure, mainly comprised of staff and causing a fair degree of fluctuations in Operating Cash Flow. In addition to ‘personnel’ we might find higher Travel and Other Expenses than in other industries. Marketing and Advertising might be a further consideration, in line with how a business might go about acquiring customers.

On face value these basic expense lines are driven by simple business drivers, but the trick to it, of course is to break things down to a meaningful level of detail so that Management has the right level of information to make informed choices and take action that counts. For example, it’s not much good to know that expenses have increased year on year by 20% in aggregate. The finer the detail (within reason), the better – we need to think about planning towards transactional level rather than at a higher nominal code level as illustrated below:

5000 – Expenses (too vague)

·?????5100 - Salaries and Wages (better but still not good enough to make meaningful decisions)

·?????5200 - Rent Expense

·?????5300 - Utilities Expense

Step 2 – Apply Enhanced Slicing & Dicing

Let’s say we are looking at employees, let’s start by breaking this down further by type e.g. FTEs or Contractors. But then we also need to cast the magnifying glass over this and understand the Grade or Attributes of those employees, in whichever manner your organisation has prescribed. These employees will also need to be assigned to Cost Centres or Departments.

We know that accurate and accessible Actual v Budget v Forecast Reports should be produced here, but to really increase forecast accuracy you must go further. Let’s think about a hiring event for next quarter: if we are going to hire 10 heads, we need to think about the associated costs with those people. Most organisations know to factor in National Insurance, Pension Costs etc and make crude, average assumptions, and stop there. But what about the complete picture? Said staff will need laptops, mobiles and there may also be other components to their remuneration structure, such as relocation allowances. Moreover, we need to think further down the track to bonus and pay rise assumptions based on individual company policy or from a regulatory perspective such as the National Living Wage. Rather than being a compromise of average or high level assumptions, your plan should represent a ‘digital twin’ capturing all material drivers appropriately.

This assumption table must be managed and maintained by somebody within Finance, with driver value changes flowing freely into the output of the plans.

Critically you must then create the plans so that you can ‘slice and dice’ the drivers on a Budget v Actual v Forecast basis down to any level required. So that for example, 10%+ month to month swings can be analysed and the right questions asked. For example, if you have the biggest event of your calendar year in the month of October, and the Travel and Expense line is showing huge variance at least you can then plan, manage, and mitigate against this proactively. Seasonality can obviously be more complicated than this but needs factoring in.

Step 3 - Increasing The Forecast Cadence

Getting the plans to properly incorporate drivers is an important step. It will ensure Op Ex forecasting is relatively accurate, but it counts for nothing if you only run the exercise once every 3 or 6 months in the current economic environment. So, increase the forecast cadence to at least once monthly, at a minimum – otherwise you’re driving blind. By thinking about a more regular cadence and measuring and monitoring the Variance Reports, your business will naturally be more proactive as opposed to the obsolete half year view, which is essentially an arbitrary exercise. In an ideal world you would plan ‘at the pace of change’ for the driver in question – realistically this isn’t possible in Excel, it’s just too much to manage and throwing more headcount at it becomes inordinately expensive for the average business. But essentially this more fluid approach to planning might generically look like this:

The point of the above table isn’t necessarily to be right or wrong, as it will be slightly different for every business, but it’s to get us thinking about what drives the business hierarchically speaking (without overcooking it) and how often we need accurate management information to make proactive decisions that can guide us to sustainable growth.

Integration Between The Financial Statements

We need to also think about the Cash Flow basis. It’s no good having a siloed headcount spreadsheet unlinked to the Cash Flow forecast. If for example we’re going to hire those 10 staff at different time intervals, we certainly need this to accurately prorate to the Cash Flow on a monthly or weekly basis (with all the associated drivers flowing through)! At a minimum you can use cell references, for example to link the Net Profit from the P&L to the Cash Flow worksheet.

The trouble with this approach is cell references are quite a crude approach and you’ll still need to manually adjust numbers. Remember, each time you interfere with a figure manually, you introduce the risk of error. Over 90% of spreadsheets contain errors (and yours are no different) so do consider the materiality of manually adjusting to reconcile the P&L and Cash Flow Statements. The impact can easily run from tens of thousands to hundreds of thousands in business or divisions with circa 10m+ expenses! Rules and validations can be setup but can be time-consuming and can depend on more advanced Excel users. So better still to consider a more appropriate technology, designed for minimisation of both error and manual human intervention.

Step 4 – Appropriately allocate/ apportion costs

Let’s think about how different departments would share responsibility for costs and how this might be planned for, taking the easy example of an IT budget.

Most of the time businesses will only apply a Fixed Base Percentage Allocation. In this simple method, each department is allocated a fixed percentage of the total IT budget. While easy to implement, it may not accurately reflect the actual IT resources used by each department nor does it provide a level of management information that empowers management to make proactive decisions to better impact the bottom line.

Consumption-Based Allocation, is an alternative which is a method whereby IT costs based on the actual usage or consumption of IT services by each department are considered. For instance, if a department uses more server resources or cloud services, it will bear a higher share of the IT costs. This is a better approach but still falls down because it might not necessarily account for shared infrastructure or fixed costs appropriately, it’s also easier for a department to be more dismissive of less visible IT activities but that could be essential – they just don’t realise it.

So, the optimal approach is Activity-Based Costing (ABC). ABC involves identifying specific IT activities or services provided to different departments and allocating costs accordingly. For instance, costs related to help desk support, software development, or network maintenance can be allocated based on the activities utilized by each department. Crucially it allows the business to continually improve processes and capture the business drivers. The only downside is it is resource intensive in Excel to execute, manage and maintain so it’s well worth considering a more suitable platform for the purposes of ABC, particularly if your organisation’s margins are heavily impacted by the near-term economic outlook.

Step 5 – Enhance Sensitivity Analysis

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Regarding all the above approaches it’s important to then be able to stress test with appropriate business considerations. Typically, businesses might apply a cookie cutter approach here and run an exercise once or twice year to say – what if revenue increases or decreases 20% or they may have a best case, base case, or worst case. This isn’t granular enough.

For headcount planning scenarios for example we need to think about:

·?????Seasonality

·?????Wage Inflation

·?????Revenue Growth

·?????Capacity Constraints

·?????Utilisation

·?????Turnover and retention

·?????Business initiatives

Certainly, you would then want to define the scenarios associated with the above more precisely than just ‘best case’. For example, ‘Revenue Growth with very high associated Wage Inflation.’ As we know, what gets measured gets monitored, so precision is our friend here. Moreover, and most businesses lack this, is the ability to apply real-time visualisations to the scenario so that we capture the ‘story of the numbers brought to life’. Scenario analysis needs to be treated fluidly to have more meaning/ impact and it’s in a carefully modelled scenario that there lies the potential to identify and incorporate the key variables that determine and ensure accurate outputs.?

Summary Of Key Steps

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·?????Capture Business Drivers Appropriately: Identify and understand the key drivers that impact the business expenses, including staff, travel, advertising, and more. Break down expenses to a detailed level to enable informed decision-making.

·?????Apply Enhanced Slicing & Dicing: further analyse and categorize employees based on types, attributes, and cost centres. Create clear Actual vs. Budget vs. Forecast Reports and consider all associated costs, such as laptops, mobiles, and bonuses.

·?????Increase The Forecast Cadence: improve forecast accuracy by increasing the frequency of forecasting exercises to at least once monthly. Monitor variance reports regularly to be more proactive in decision-making.

·?????Integrate Financial Statements: ensure proper alignment between headcount planning and cash flow forecasting. Link Net Profit from the Profit & Loss statement to the Cash Flow worksheet for accurate prorating.

·?????Appropriately Allocate/Apportion costs: Move beyond fixed base percentage allocation and consider activity-based costing. Allocate costs based on specific activities or services provided to different departments for better accuracy.

·?????Enhance Sensitivity Analysis: conduct comprehensive stress tests that consider various business factors such as seasonality, wage inflation, revenue growth, capacity constraints, and turnover, and define precise scenarios for better measurement and monitoring.

·?????Emphasize Real-Time Visualizations: utilize real-time visualizations to bring the data to life and gain deeper insights. Make data-driven decisions to ensure sustainable growth and success in the service industry.

Conclusion

Many planning professionals will be aware of the principles contained in this article but for various reasons fail to put them into practice. It's worth considering though that planning is a process of continuous improvement and by taking a step back and implementing the steps above we can dramatically improve forecast accuracy in a tangible way.

Today, we have approached the issue from a process enhancement standpoint. Adopting, these recommendations will ensure improved plan accuracy for your organisation.?However, it is equally crucial to consider the role of data, technology, and people (adoption and change management, particularly around cultural attitudes to planning and budgeting) to get the most out of your planning processes.

To explore this topic further, feel free to reach out with any comments and questions. I’d be delighted to have a best-practice discussion with you.

Peter Dixon