Financial planning and analysis (FP&A) is the process of analyzing an organization’s financial strategy. To accomplish this, we need a prediction of a future P&L and cash flow or, in other words, a forecast. Many companies however do not create forecasts, instead operating from budgets, sales targets or some KPIs developed by the Finance department.

None of these are an adequate substitute for a robust forecast.

One of the oft-lamented drawbacks of the annual budget is that it is static in nature and it ignores changes in the marketplace throughout the year. Targets are set based on the various assumptions identified at the beginning of the year and sometimes, before the final budget is signed-off, many of these assumptions are already out-of-date and irrelevant. That reality was driven home in spectacular fashion by the last recession, which saw many carefully prepared budgets rendered meaningless.

Standard Financial Plans Are Disconnected From The Drivers Of The Business

The problem with these kind of budgets is that the forecasting process is disconnected from the specific drivers of the business. It fails to understand that the purpose of forecasting is to provide a picture of the strategic direction of the organization, identify potential risks and opportunities, and coordinate future activities. It is not a performance evaluation tool or a revalidation of the company’s commitments. When forecasting is used as annual performance evaluation yardstick, chances are that executives will purely focus on achieving the targets set at the beginning of the year.

But when the forecast is tied to sound predictive analytics, current sales, and changes in markets, executives have more timely and accurate information that allows them to make better decisions. What’s more, by tying the financial plans to the monthly forecasting cycle, executives can eliminate the annual mindset and become more aligned to business cycles. It is critical that instead of planning once a year on a top down number you are told to hit, forecasting is based on real business demands and the real business environment – and for that we need to update the plan more regularly.

The Power Of Rolling Financial Forecasts

To do this, many companies are abandoning the annual budget and moving towards a rolling forecast or continuous planning. This is a process in which key business drivers are forecasted on a continual basis. To do this, Finance must not try to recreate the annual budget process every month, nor should they shortcut it and just use averages.

Forecasting a P&L is about estimating revenues of sales, costs of goods sold, and SG&A costs (selling, general and administrative expenses) for the upcoming period. At first glance, a tempting and time-saving approach for the organization might look like a summarized P&L for the forecast period. Much better, however, is a more detailed P&L elaboration, reflecting fact-based past experience, the best available knowledge and the soundest assessment of the future environment and business development.

Finance Must Work With Demand Planning

For this reason, the forecast should not be the sole work of the Finance department, for it may not have all elements available to make its own assessment of how the market is developing. Instead, it should be the result of collaboration with the predictive analytics and demand planning functions. Working together they can get the complete picture more efficiently and effectively.

Finance must work with predictive analytics and demand planning for a truly robust forecast

This coordination ensures best practices in data gathering and analysis, modeling, managing assumptions, and, just as important, monitoring performance. Good forecasting and demand planning help us better understand the uncertainty of demand and adapt to changing conditions.

Furthermore, developing a monthly P&L and rolling forecast using the forecast created by the demand planning and forecasting function creates a one number attitude throughout the organization. In this scenario, the same forecast that drives Operations and Sales and Marketing is now driving gross margin, variable cost, and cash flow. While there may be allowances and other financial adjustments to the sales forecast, using the same baseline allows you to tie and understand the drivers and variables better.

What The Rolling Forecast Most Definitely Is Not…

Finally, the rolling forecast is not an annual budget done twelve times a year. If it takes you eight weeks to recreate a forecast every month, you may have a problem. Using the sales forecast generated by demand planning is not only a best practice but saves time and resources and allows finance to focus on financial drivers.

In this new business environment where we need more insights faster and be more agile, we need to leverage resources and processes that are responsive and understand customer demand. As today’s culture of ‘disruptive’ thinking begins to permeate every corner of business, approaches to processes such as budgeting and financial forecasting are also evolving. Being adaptable and collaborative is now the name of the game, and if a company’s finances can’t keep up with ever-changing scenarios, the outlook is grim.

Forward thinking companies have recognized that traditional financial forecasting is inefficient and are getting demand planning to help

Today companies have recognized that traditional financial forecasting is inefficient and have moved to demand planning function or specialized planning and forecasting roles to help. Advanced predictive analytics functions are being leveraged throughout all parts of organizations and for FP&A, it can be a source of strong competitive advantage. This is also the basis of a good rolling forecasting process which invokes consistency and participative cooperation across functions in organizations.