Thoughts on Budgeting - Part 7: Rolling Forecasts

Prior topics in this series:?Thoughts on budgeting,?Potential Drawbacks of Budgeting,?The Budget As A Forcing Function,?How To Improve The Process & Level Up Your FP&A,?Excel is Amazing & Awful, Driver-Based Budgeting

What problem are we trying to solve?

In a previous article (Potential Drawbacks of Budgeting) I mentioned that a common criticism on the traditional budget is that companies spend a significant amount of time preparing it (often 3-5 months) only for it to be out of date soon thereafter. This can create significant problems as the budget directs resource allocations and is used for variance analysis.

What is the solution?

The solution is to update the budget regularly throughout the year, to implement a rolling forecast.

With a rolling forecast, a company typically updates the budget monthly or quarterly (you could do weekly forecasts of key variables if the business sees value in doing so, for example to estimate the lifetime value for recently acquired customer cohorts and expected impact on profitability).

This ensures the company always has a forecast that reflects the current business environment, both internal and external.

Also, as the forecast is updated, you add additional months to the end of it, ensuring you always have a forecast covering, at least, the next 12 months.

How to implement a rolling forecast?

What is updated?

There are many paths companies can take here. One example would be to update the forecast monthly:

1. Update the forecast for the upcoming month in detail
2. Update the forecast for the following 2 months at a slightly higher level
3. Review the forecast for the remaining months to determine whether any updates need to be made there (including the new month you add at the back of the existing forecast)

Detail & work involved

Be mindful of the investment required vs. the value derived.

Updating the forecast can easily become a significant monthly task, taking time away from other activities, so it is vital that the update generates value, such as:

• A more accurate revenue forecast for the upcoming month based on contracts being closed, projects started, etc.
• Improved cash management due to having better insights into collections
• Improved resource allocations based on current requirements and business environment

Except for key items in the short term (e.g. larger items for the upcoming month), it might not be worth doing a full zero based budgeting exercise for most items. Attempting to do so monthly can create a significant amount of work for a large part of the organization without any clear return on that investment.

Additionally, as we've all experienced, the budget can often be a challenging exercise with continuous back-and-forth as departments request resources (e.g. significant growth in headcount) and opening the entire budget up for discussion and review monthly to update the rolling forecast might not be an ideal use of everyone's time.

The goal with a rolling forecast is NOT to simply repeat the traditional budget process multiple times throughout the year.

Here's one path companies can take when updating their rolling forecast:

• For the upcoming three months (task 1 and 2 here above): Spend some time reviewing the forecast in detail. This could mean doing a bottom up budget for major items (largest clients, projects, vendors, etc.). Also, review items that have been especially volatile. Talk with key stakeholders to identify specific concerns and areas that might require deeper focus. The FP&A team plays a key role here, by keeping an eye on what items should receive a close look every month, and these items can change from month to month.
• For the remaining months in the forecast (task 3): You can likely update these months based on trends and high level expectations (e.g. use key ratios in the financial statements to generate these, look at trends, etc.). Again, FP&A plays a key role in guiding this work and ensuring those items that require a closer look get the attention they need (and then providing insights to the appropriate stakeholders to assist in that work).

Scenario planning

As you go through the updates, run through scenarios to identify potential risks. For example, check for changes in margin ($ and %), cash balance, etc. Use your driver-based models to check trends in KPIs and discuss remedial actions if needed (e.g. if cost pr. headcount is trending up, discuss why that is happening and whether remedial action is required).

Strategy execution

Ideally you have your strategic initiatives clearly tagged in the budget and the forecast. This allows you to check whether those initiative are still on track. Things to look out for are changes in investments/resources/funding/R&D/etc. that might have been made (or are expected to be made according to the latest rolling forecast update) and could put those strategic initiatives at risk.

I will be writing more about budget/forecasting and strategy execution in a later article.

What budgeting system you use matters

I have mentioned in previous articles that it is vital for companies to look into implementing a proper budgeting system (How To Improve The Process & Level Up Your FP&A, Excel is Amazing & Awful).

If you are using a typical Excel based process, implementing a rolling forecast will be more difficult due to how time consuming the process can be (likely involving multiple files being sent out to people, multiple copy/paste processes to consolidate the data, etc.).

If you have a planning system such as Adaptive Planning or Anaplan then creating a rolling forecast can be as simple as:

1. Duplicate the previous rolling forecast version
2. Send a notification to stakeholders with directions on what data they are expected to enter
3. Monitor progress in the planning system (and participate in discussions behind those updates, e.g. meeting with the sales team to provide insights that will help them update their forecast)
4. Lock the version from editing by others than FP&A
5. Run through scenarios and make the necessary updates (involving the appropriate stakeholders)
6. Lock the forecast version from further updates
7. Prepare reports for the Board, etc.

Cultural & organization requirements

It is important to ensure that the rolling forecast is not simply an administrative exercise. This means that everyone needs to understand the role of both the original budget and the latest rolling forecast. This can mean reviewing how compensation plans are designed, reviewing what materials are shared with the Board (it can't just be comparisons with the original budget), etc.

If the rolling forecast is not integrated into the proper processes then it is likely the company will continue to focus exclusively on achieving the targets set in the original budget and the rolling forecast will not be of significant value.

Impact on the annual budget process

When you have implemented a rolling forecast process you should always have a forecast that looks at least 12 months ahead. In addition to the benefits discussed above, this can be invaluable when it comes to creating a budget for the coming year as you already have a view of what that year might look like.

For example, in September of 2023 you should have a rolling forecast taking you to September of 2024. This can be a great starting point when preparing the budget for 2024.

However, be careful to not be blinded by the forecast. You should still use the budget process as an opportunity to fully explore goals and expectations for the coming year.

Actuals vs. Forecast vs. Budget

Comparing actuals to the original budget can still be valuable!

The original budget contains the company's initial expectations and goal setting for the year. It provides a baseline to compare with to see how far the company has possibly gone off the course initially laid out for it.

You can foresee a situation where a company has missed its targets for a few months and the latest rolling forecast reflects that. If the original budget is not part of the ongoing discussion, then this deviation from the original path laid out for the year could be missed. In this case, the company should discuss why recurring misses are occurring and how it can possibly get back to the targets set in the original budget (if that is feasible, and if it is not then the Board and other stakeholders need to be made aware of that).

Comparisons with the original budget are also likely required for quarterly reporting to the Board and investors.

More on budgeting later...

• Eggert