Business planning is at the forefront of business strategy in 2019. It has become one of the most critical functions for business and forecasting is an essential part of this. Business decision makers would need to make financial forecasts to identify hurdles for growth for the following year, cash availability, value of a business and potential opportunities.
If it is so important, why are business and economists still struggling to produce accurate financial forecasts?
The problem with the future
Probably one of the main issues with producing accurate financial forecasts is that assuming the future is practically impossible. Even the most likely events have a probability of changing in the future, i.e. if the weather forecast says it is going to rain, and the clouds gather, slight change of wind might mean that it will pass.
Therefore, predicting the future is quite a difficult task, even when you have a large number of variants available to you. Just think of all of the economist forecasts of Brexit Britain, all of the forecasts of financial growth after the financial crisis, they all come with a few percentiles of variance. But if we approach financial forecasting with a mindset of “unpredictability” and instead use forecasting methodically and mathematically while considering a range of possibilities and probabilities for each of them, we can make better business decisions based on the same information and apply more flexibility to a future business strategy.
Precision is the problem
Decision makers are eager to create the most accurate financial forecasts and follow them to the teeth. After modelling every input and strategically planning every scenario, the thoroughness makes the forecast look scientific and well thought out. However, the complexity and precision of the forecast often can conceal problems.
When it comes to accurate financial forecasting, a good analyst will tell you, that it is impossible. And many claim that is much more about being approximately correct than precisely wrong. Alongside this, professionals in the industry tend to apply a predicted percentage variance in their data, to add a pinch of salt to their forecasts.
Lack of reviews
Above all else, one of the major pitfalls of financial forecast accuracy is the lack of a serious review. Companies create the forecasts as if they would be the goals of the new year. On top of that, forecasts are often done by a single individual aren’t reviewed by anyone. They are subject to a single person’s bias and not regularly reviewed for accuracy during the year. This removes the potential of finding any mistakes and refuses the opportunity to do better next time by the company itself.
While this all may sound like achieving financial forecast accuracy is a waste of time, it is far better to acknowledge these limitations and accommodate them rather than deny any opportunities you would achieve by this process.