enterprise performance management

This is a guest blog post from our partner Workday Adaptive Planning, explaining how great financial forecasts can guide business strategy.

If 2020 taught CFOs anything, it’s that they need well-executed financial forecasts and models from their FP&A team. Accurate forecasts help finance leaders make insightful, data-driven decisions, allowing their organizations to prepare for market conditions and trends, adapt to revenue and expense fluctuations, and execute strategic action plans.

So, if you’re interested in creating more accurate and reliable forecasts that can warn finance leaders when they need to make major changes, read on. You’ll learn how to create the kind of financial forecasts that guide business strategy.

Build an accurate business model

Before you can build a comprehensive financial forecast, you need to construct a well-designed business model. One way to do that is by modeling revenue. An effective revenue model should be able to answer questions like, “Which investments and actions are necessary to grow revenue by 25% next year?” Or, “If revenue remains flat, which programs should we cut to maintain profitability?” With the right model in place, you’ll have the flexibility to run scenarios and examine assumptions so you can answer these questions with confidence.

The purpose of revenue models is to forecast the sales volume and mix of products and standard service line offerings. They will vary widely based on your industry and business model. For example, a manufacturer might consider variables like capacity and utilization, while a law firm might look at client lists and billing rates. Whatever the nature of your business, the right model will help you get a better handle on revenue so you can drive your business forward.

Consider the money going out

In addition to the dollars coming in, your financial forecast will need to consider the money going out—expenses. Consider these key factors when modeling your expenses.

• Personnel. This is likely your largest expense. If your organization is primarily salaried employees, you might forecast personnel expenses on a per-employee basis. If, however, you are a national retailer or restaurant chain with a large number of hourly employees, you may prefer to build a forecast based on work shifts or job roles.
• Operating expenses. These are often tightly correlated with headcount. Your expense model should reflect that.
• Cost of goods sold. You will need to forecast all costs associated with the delivery of revenue—including labor, materials, and overhead.
• Fixed versus variable costs. Understanding what drives an expense is critical to getting the modeling right. A fixed cost (such as a data center) should be modeled in a way that it is not impacted by changes in revenue volume, while a variable cost (such as raw materials and packaging) might be modeled according to a formula (e.g., as a percentage of total revenue).
• Overhead cost allocations. In some cases, you’ll want to trace and assign costs across segments or cost centers and possibly further to products, standard service lines, and ultimately to customers. Distributing IT expenses across multiple departments, for example, may help you understand the “fully loaded cost” of IT’s services to its various internal users. Begin by identifying “drivers” as the basis of your expense distribution. For instance, some overhead costs might be based on the number of customer orders or, for manufacturers, based on the number of material moves or machine setups. “Drivers” reflect the consumption view for how outputs consume expenses with a cause-and-effect relationship. (Activity-based costing is often used for this calculation.)

Get rolling with rolling forecasts

Once you’ve built your revenue and cost model, it’s important to define a frequency interval cadence and a calendar to recalculate the model. Financial forecasting is not a one-off exercise, but rather a practice to develop and refine over time.

By implementing a rolling financial forecast approach, you can revisit and update customer demand forecasts continuously based on actual data and performance to allow on-the-go course-correction as conditions and context change. Continuous forecasting helps you answer critical questions such as, “How are we doing against our plan?” and, “How should we adapt our plans and actions going forward?”

While some reforecasts may occur on an ad hoc basis, you should establish a consistent frequency cadence, whether semiannually, quarterly, or monthly. Each reforecast is an opportunity to assess performance and revise assumptions about the future. Your reforecasts can live alongside your original plan (and in some cases your annual fiscal budget) and represent your latest and best predictions of business performance and planned outcomes.

In some cases, you may need to generate forecasts on a much more frequent basis. Retail, hospitality, and other highly seasonal businesses may engage in daily or weekly monitoring to reflect customer shopping patterns. Other businesses may choose to do a flash weekly forecast around the product or service offering sales volume and mix or on other operational key performance indicators (KPIs) to ensure they remain on track.

Define your reporting process

Once you construct a comprehensive model of your business and incorporate your insights and assumptions into your financial forecasting process, you need to define a set of reports to be used (both internally and externally). Your reports should provide an easy-to-understand view of company health. They should include more than just a financial income statement and balance sheet view plus a pro forma net cash flow of your company’s finances. They should incorporate the monitoring of performance of both strategic KPIs and operational process-based performance indicators that you can easily share with your board of directors and management teams.

An efficient reporting process isn’t just about the reports you generate. It’s also about how you get there.

If you manage reports using only spreadsheets, then you’re familiar with the process of bringing together all your data sources, manually importing them into various spreadsheets, and emailing them around for approval. And that doesn’t even include the ad hoc requests you receive by email or from people passing you in the hallway.

The key to getting everyone the reports they need, faster and more accurately, is automation. An automated platform simplifies the gathering, reconciliation, extraction, and validation of your data. That alone can transform your reporting processes from a monthly hassle to a dynamic, ongoing influencer of organizational change.

Drive collaboration

So, you’ve automated your reporting. You’ve established a regular frequency cadence. And you’ve amazed your stakeholders with the insights you’ve shared. But if you’re still the gatekeeper of information, you may be missing out on a tremendous opportunity. When stakeholders are not directly involved in the planning process, they don’t feel a sense of ownership.

When data is accessible through self-service financial forecasting tools, people will be more likely to adopt a proactive approach to gathering critical finance data, and they’ll come to embrace your plan as their own.

Choose the right modern planning software

To help you take these steps, you’ll need the right financial forecasting tools. While Excel is where most finance teams get started, it’s not built for scale. As organizations grow and data sources multiply, organizations must turn to a cloud finance solution that can:

• Facilitate collaboration. Get everyone in your organization involved in the planning process by giving them access to real-time data so business partners can take ownership of the numbers that they will likely be held accountable for.
• Enable multiple what-if scenario planning. Combine high-level, top-down growth- and profit margin-based models with detailed, bottom-up personnel rosters and schedules in a single platform so you can quickly reconcile differences and address gaps.
• Provide a single source of truth. With a core set of operational and financial data that’s common across the company, you can align the organization with the executive team’s strategy and monitor the organization’s performance in executing the strategy.
• Automate reporting. With centralized reporting and automated data integration, you can eliminate the need to hunt for and manually aggregate data. That frees up more time to focus on analysis while providing stakeholders with the information they need to make better, faster decisions.

Financial forecasting comes down to answering a few key questions: How well can you understand your company’s position in the context of the economic environment? How much insight can you display into what’s driving opportunity and risk and causing problems? And perhaps most important of all, how ably can you communicate these insights to decision-makers throughout your organization? With the right financial forecasting tools, you can have all those answers right at your fingertips—and you can help every team member feel part of the process.

This blog post was originally published on the Workday Adaptive Planning blog.