Five Core Components of a Rolling Forecast

The traditional annual budget and the ensuing updates, estimates or forecasts to the budget, are the primary tools in use today to manage the financial and operational performance of an organization. However, due to a low level of detail and extensive politicizing of the process, the traditional annual budget often takes too long to create and is out-of-date by the time it is completed, leaving an organization without a functioning plan for much of the fiscal year.

In an attempt to address this problem, the concept of a rolling forecast is gaining traction and is being adopted successfully by various organizations spanning a range of industries around the world. A rolling forecast creates an ongoing cycle of planning, conducting, evaluating and updating organization-wide operations. Executing and implementing a rolling forecast properly will enable an organization to become more agile and dynamic in its business planning process. Though there are many definitions of a rolling forecast, all successful solutions must contain these core components:

Extends beyond the calendar/fiscal year and cover a standard number of periods
Traditional forecasting processes chiefly serve the purpose of updating projections against the baseline set by the budget. The final horizons align with the budget, usually to the end of the calendar year, disallowing the organization the opportunity to extend their outlook and align itself with the actual business cycle. A rolling forecast should ideally be aligned to the actual business cycle regardless if it is 12 months, 6 quarters or 2 years, and is independent of the calendar year.

Updates on a regular and pre-determined basis
Recent research conducted by CFO Magazine and published on the cover of their May, 2011 issue   indicates that most companies perform updates to their budgets during the course of the year. However, these updates are often not completed on a regular basis or the same way every time. A key requirement of a successful rolling forecast is that it needs to be updated in an ongoing and consistent process. The same tools and processes need to be used the same way for every forecast cycle. This consistency enables a number of beneficial behaviors and results. Activities that are conducted infrequently usually take longer to complete and are more fraught with errors than those that are completed regularly. By doing it the same way each time the organization falls into a rhythm that can be planned for and accommodated. This repetition allows the process to be completed more quickly and efficiently each time. Basic tasks become routine and can be completed quickly or automated leaving more time to the difficult value added work.

Traditional forecasts combine recent actual data and updates to the budget to recompile full year projections. As another month of actuals are available, one less month of forecasts are updated. These x/y forecasts often are referred to as 1/11, 3/9, 4/8 or 8/4 forecasts indicating that there are x months of actual and y months of forecasts, but x + y always equals 12, meaning that the focus is always on one full year. In other words, the May forecast will be four months of actuals and eight months of forecast, while the September forecast will have eight months of actuals, but only four months of forecast.

In contrast, a rolling forecast keeps y constant so that it is always looking forward by the same number of periods. As rolling forecasts become adopted and ingrained, this is adapted slightly, but the core concept stays the same. The benefit of this approach is that the number of forecast periods is dictated by real business drivers such as business cycle, competitive forces, price sensitivity, vendor reliance, business cycle and technology adaptation. None of these real issues are taken into account in the traditional budgeting process but are critical for managing future operations.

Emphasizes key business drivers
Another key component of rolling forecasts is its focus on key business drivers. These drivers are business decisions or influences that impact numerous areas and ideally link revenue and expense activities. For example, a price decrease of 5% may increase overall units sold and possibly keep revenue flat, but because of the existing cost structure may result in margins falling by 10%. Or, it may show that the additional costs of hiring a sales manager may be more than offset by the additional productivity and margin improvements of the sales team. These business decisions are reflective of those that are occurring within organizations on a constant basis and thus are the main focus of a rolling forecast. To understand the true benefits of this process, it must be compared with the existing forecast process that is often completed at the same level of detail as the chart of accounts. This level is often not intuitive for the typical business manager. Managers think in terms of hiring and firing staff to meet demand, not in terms of the various lines in the general ledger such as salaries, benefits, fringe, payroll loss, FICA, FUTA, SUTA, etc.; yet this is how they are expected to enter and update their financial projections. As a result, the traditional forecast becomes more of a spreadsheet exercise than a business management exercise.

Rapid forecast creation
Rolling forecast solutions that leverage business drivers can be completed quickly. Instead of spending hours to translate business decisions into financial terms, update a spreadsheet and then rebalance the numbers to ensure that full-year targets have not changed, a rolling forecast requires only that key decisions be entered. For example, how many people will be needed, how many units will be sold and what the pricing structure will be. These decisions are converted to financial projections quickly and accurately so that valuable staff time is spent making the right decision, not auditing spreadsheet models. Ideally, an organization with a fully mature rolling forecast solution will be able to generate an enterprise-wide forecast in less than one business day. What would you do with that capability? How long does it take your organization now?

Blends actual performance along with the updated forecast
Utilization of the most recent actual data available is an essential component of a rolling forecast. This data set serves as the best reference point not only for what actually happened, but also how that performance compares to what was projected. To leverage a rolling forecast properly it is critical to examine actual results and forecasted performance through the same lens. Management must determine how many periods of actual data should be analyzed and ascertain the level of detail needed from a time and account perspective to provide a complete picture.

A rolling forecast is much more than simply adding one period to a traditional forecast and dropping one period of actuals. It is critical that the appropriate effort is spent on analyzing what has recently happened, why it occurred and what will be done in the near future. The vast majority of effort should be spent on updating periods that were previously forecast, not on the new periods added to the forecast. The further into the future a period is, the more variability and forecast error there is; therefore, it is best to focus the adjustments in the near periods as those are more controllable and predictable.

A rolling forecast solution can provide many benefits to an organization in terms of reaction time, alignment of operations, and activities and timelines.  It allows management to focus on making decisions that truly matter and have far-reaching implications that can propel the organization towards their strategic goals and overall vision. Done correctly, it will provide true competitive advantage in a constantly and rapidly changing business climate.