Do you ever feel like you’re caught in a forecasting Groundhog Day? You know, the movie where Bill Murray keeps reliving the same day over and over again? If only your business planning process was that simple! Unfortunately, it’s not. Forecasting is hard. It’s even harder when you’re trying to create rolling forecasts – predicting future performance based on past results. But with driver-based forecasting, it doesn’t have to be so difficult. Driver-based planning is a process for modeling business performance based on the key levers that are most impactful to the organization.
What Is Forecasting?
Forecasting is the process of looking at past and present data, as well as marketplace trends, to predict the company’s future financial performance. It enables you to gauge how much revenue you’ll potentially earn in a particular period and plan for big expenses. Driver-based forecasting takes this one step further.
What Is Driver-Based Forecasting?
Driver-based forecasting, sometimes referred to as driver-based planning, is a process for modeling business performance based on the key levers that are most impactful to the organization. Building financial models around the value drivers for your business keeps all planning and budgeting processes focused on answering two main questions: how are we going to grow as a business? And how is that growth going to produce desired results?
Driver-based forecasting starts with understanding the difference between drivers and assumptions. Drivers, compared to assumptions, have a direct impact on your company’s financial performance. For example, if you’re in the business of selling widgets, the number of widgets you sell is a driver. The price of each widget is also a driver.
Why Is Driver-Based Forecasting Important?
If you’ve ever tried (and failed) to implement rolling forecasts in your organization, poor driver/assumption construction might have been to blame. That’s why effective driver-based planning starts with understanding the difference between drivers and assumptions.
Creating a driver-based forecast forces you to think about what’s driving your business results. It also forces you to think about how those drivers will change in the future. This is important because it allows you to make forecasts that are based on real data and trends, rather than guesses or gut feelings.
Driver-based forecasting is also a more dynamic way of forecasting than traditional methods. That’s because it’s constantly updated as new information arises. This makes it a more accurate predictor of future financial performance.
The Driver-Based Forecasting Process
Step 1: Identify The Drivers That Impact Your Business Results
The first step in driver-based forecasting is to identify the drivers that impact your business results. These can be internal factors, such as the number of products you sell, or external factors, such as the price of raw materials.
Step 2: Estimate How Each Driver Will Change In The Future
The second step is to estimate how each driver will change in the future. This step requires you to have a good understanding of industry trends and your company’s competitive landscape.
Step 3: Build Financial Models That Relate Your Drivers To Your Desired Results
The third step is to build financial models that relate your drivers to your desired results. For example, if you’re trying to forecast sales, you would build a model that shows how changes in the number of products sold impacts sales.
Step 4: Run and Adjust the Forecast
Once your model is set up, you simply need to run it and adjust the inputs as needed. You will want to do this on a regular basis, especially if your business is growing or changing. Forecasting is not a one-time event; it should be done regularly to ensure that your numbers are accurate.
Step 5: Review and Summarize
You should look at your forecast results to ensure they make sense and summarize them in a way that works for your business. For example, if you are forecasting customers on a monthly basis, you may want to do quarterly and annual views. If you are forecasting by store, you may want to view by region. You may even want to look at trend views to ensure there aren’t any outliers.
Driver-Based vs Historical Forecasting
Historical forecasting is a type of forecasting that relies on past data to predict future outcomes. Driver-based forecasting, on the other hand, relies on an understanding of the drivers that impact your business results.
Driver-based forecasting is more accurate than historical forecasting because it takes into account changes in the marketplace and within your company.
Pros of Driver-Based Forecasting
There are many benefits to driver-based forecasting, including:
-It’s more accurate than historical forecasting.
-It takes into account changes in the marketplace and within your company.
-It’s a more dynamic way of forecasting.
-It’s constantly updated as new information arises.
Cons of Driver-Based Forecasting
There are a few potential drawbacks to driver-based forecasting, including:
-It can be time-consuming to identify all of the drivers that impact your business results.
-You need to have a good understanding of industry trends and your company’s competitive landscape.
Tips and Tricks
Finding Data And Assumptions
Forecasts are only as good as the data and assumptions you put into them. So where can you find solid data? If you have an existing business, the first place to look is your financial system. Historical data is one of the best inputs to a forecast. You can also work with your operations teams to understand what it will take to deliver a certain level of performance.
For a new business without historical info, you will have to dig a bit deeper. Economic data and market research are your best bets. This can include digging into resources like the Consumer Product Index (CPI) for inflation or studying your competitors.
Step Back And Do A Gut Check
As you get into the weeds of your forecast, it is important to step back and ask yourself, “Does this make sense?” Think about how the forecast looks year-over-year and sequentially. Do you have the capacity and workforce to even deliver the forecast? Do the trends seem reasonable or are there unusual outliers in the forecast?
It is critical to sanity-check your work and ensures you put out a great product
Build For the Future
When working on a forecast, do yourself a huge favor and build it for the future. Well, obviously a forecast is for the future, but I mean the model itself. If you are running a forecast today, you are likely to run the forecast again. Make sure the model is dynamic enough to pull in new actuals and roll forward for future time periods. Avoid hardcoding, and try to link everything up to data tables. Make it clear which periods and cells are actuals and which are forecast.
This may take some extra time to set up, but it will really pay off down the road.
When it comes to forecasting, driver-based forecasting is the way to go. This method is more accurate than historical forecasting and takes into account changes in the marketplace and within your company. It’s also constantly updated as new information arises, making it a more accurate predictor of future financial performance. Driver-based forecasting is the key to successful planning!
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