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January 2014
Rolling Forecast: The Budget Alternative
By Michael Waddell

     The benefits companies receive from traditional annual budgets may be diminishing. Given the current economic environment that most businesses face, they are constantly dealing with volatility and ever changing risks, thus the past is not always a good predictor of the future.

     Budgets are created based on prior periods and management assumptions, which now may be wrong. According to the Beyond Budget Round Table, by the end of the first quarter more than two-thirds of a corporation’s budget is completely irrelevant to actuals. Flexible planning is now vital to the ongoing financial success of a business and a stagnant, fixed-period budget leaves no room for actual implementation of change to match the environment.

     Because of inefficiencies with traditional budgets, many companies are converting to a rolling forecast. With a rolling forecast, projections are reevaluated in shorter spans—for example, every quarter—then forecasted out a standard number of periods, usually 12 months. This allows companies to reevaluate assumptions and adjust forecasts closer to actual market conditions.

     Rather than having a full year projected out and running down to zero and then starting the process over again, the rolling forecast allows for a continually updated horizon. Allowing the forecast to change, companies can then more closely monitor and evaluate their business on an ongoing basis, which holds managers accountable throughout the year rather than just at the end of the budget year.

     Companies may start with an annual budget and then move to a rolling forecast at the end of the second or third month. The result is three months of actual results and nine months of projections. This process is continued throughout and into the next calendar year. By merging actual data into the budget, companies gain greater clarity into what is driving current results. It also forces managers to more closely monitor and track their financial performance.

     Rolling forecasts give better insight into possible downturns or upturns, giving leaders an opportunity for discussions to help avoid or handle situations. With the greater ability for cash flow analysis, it allows decision makers to consider and structure large transactions on a timelier basis. There also is room within rolling forecasts to perform scenario and stress testing throughout the year which is almost nonexistent with a traditional budget.

 

Rolling Forecast: How to Get Started

     Initial implementation of a rolling forecast may run into some resistance and can be time consuming, but it will reap worthy benefits for the company as it is streamlined. The most important factor in transitioning from a traditional budget to a rolling forecast is ensuring people in the company are willing to take part in the process. This can be done by getting employees to understand a rolling forecast will save time for departments and allow more time for focusing on driving actual results.

     The company’s business will determine the complexity of the forecast and the drivers that need to be reevaluated and emphasized. The frequency for which critical drivers need to be updated depends on their importance to the company and their variability. Some items should be reevaluated weekly; others can be reevaluated bimonthly, monthly or quarterly. For some businesses an ad hoc approach is more reasonable with only significant changes prompting reforecasting.

     Forecast assumptions should also be based on underlying physical factors and not on the hopes of management that things are going to improve. Also, different time horizons can be used as the company evaluates different planning decisions when dealing with factors like sales, operations, finances, and capital projects.

     Since actual current data drives the rolling forecast, it is important for a company to maintain accurate and timely data that is usable and accessible by all vested parties. Depending on the size of a business, basic rolling forecast data may be maintained using simple spreadsheets. For larger or more intricate businesses forecasting, more complex software can be used to allow for consistent and flexible changes of assumptions with trusted output.

     Processes should be repeated, but as the needs and priorities of the company change, models should be adapted to properly reflect business evolution.

      But don’t get too bogged down in the detail. Most importantly, make sure the information is instructive, actionable, and showing you things you may not have known before, allowing you to act upon those revelations.

 

Michael Waddell is a Financial and Management Consultant at Potter & Company.
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