Having trouble budgeting and forecasting?

So, there are many people that are considered visionaries.  For general market and sociological trends, folks like Alvin Toffler and Faith Popcorn have provided their personal insights into the future.  They do extensive research.  They need to analyze a lot of data because the complexity of the environment they are considering is enormous.  With all the raw data that is out there, how do they do it?  They employ lots of people to summarize vast amounts of data.

Closer to home, the question you have to ask yourself in planning the future of your business or organization, “Is it important to my strategies and what level of research do I need to perform to assist in properly positioning my organization?”.

With the power of technology, there are many disciplines that are continuing to advance the ability of being able to predict the future.  Weather is something that we all pay attention to in varying degrees.  From agriculture to the daily commute, everyone has an interest in the weather.  And as computers have become more powerful, so have the predictive models.  And it seems that weather forecasters are just as wrong as before.  And predicting weather still eludes many forecasters when the best true predictor of the weather today is still yesterday’s weather.

Let me ask you this.  When you are planning your budgets for the next year, what is the most difficult to predict, revenues or expenses?  I would guess that most of you have a harder time with predicting revenues or sales or the “top line”.  For this post we’ll spend more time talking about forecasting revenues for your product or service.  Most expenses are fairly predictable.  Most expenses are either fixed and therefore, the same as last year, or they are variable with revenues.  So unless you have a good idea where your revenues are going, then your variable costs will be just as wrong as your predicted revenues. 

When forecasting revenue, using a little science and a little art is required.  The science part is when you look at past revenues and look at three characteristics: 1) the overall level of sales, 2) the trend and 3) the seasonality of your business.  For the more mathematical minds out there, this is y = a ± bx ± cx².

The level of sales has to do with the base level of past sales. The easier way to think about this is either you are General Motors or you are a main street gift shop.  When looking at the past 2-5 years, you can generally estimate the base level of your revenues.

The trend of your business is which direction your business is going (hopefully up and not down) and to what degree of growth or decline you have experienced.  If you have experienced a 5% annual growth in revenues over the past 2-5 years, then it would seem most likely that your revenues will continue to grow, all other things remaining equal.  In these economic times, this number is probably the most difficult to predict.

The seasonality of your business is more dependent on what you are actually selling and when your customers want to buy what you are selling.  This is just a guess but I can imagine that snowboards probably sell better during the winter than in the summer and bicycles probably sell better in the spring and summer than in the fall and winter.  These are just a couple of examples.  You have to look at your entire marketing plan to find out what affects the selling of your product or service. 

I have described the basics of the science of predicting revenues for your product or service.  The art of forecasting is a little trickier.  As we all know, the past is not necessarily the best predictor of the future.  The external environment always has something to throw at you that can make you scream.  There may be market trends that are different from your business’s trends.  Interest rates may go in an unpredicted direction.  Competition may get a new cost advantage and put pressure on you to lower prices, thus lower revenues.  Others may be increasing their promotional budgets causing you to lose loyal customers. 

These are just a few of the possibilities where the external environment can significantly impact demand and revenues.  The trick is to try to get as much information as is financially feasible.  Now comes the balancing act.  The more information you have and the more time you invest in budgeting, planning, forecasting or estimating, the more accurate you will be.  And at some point there is a point of diminishing returns.  And there is point when you need to pay attention to the day-to-day operations of your organization.

Just remember one thing: your marketing plan is what directs your business and what will help in your ability to accurately predict demand and revenues.