How to Make Realistic Growth Projections
Forecasting is the process of identifying what events are likely to happen
in the future and to benefit from these events.”
-American Institute of Certified Public Accountants Library—Definitions 2012
Every business needs to conduct forecasts. Forecasting is an essential part of any plan for the coming year or months. Decisions need to be made about quantities of raw materials, supplies or finished products to have on hand. Staffing levels have to be assessed so the company can respond to the coming demand. Cash flow needs must be addressed as well.
Forecasting literature focuses a great deal on predicting demand or revenue for the next year(s). While expenses also have to be forecast, predicting revenue is the challenge. Expenses will flow from there. Expenses can be fairly accurately figured based on past history, sales projections and solid research into what things cost. Sales require much more “art.” A starting place is a historical trend line of sales, including seasonal variations along with industry and national economy forecasts.
The process: Typical forecasting steps
1. Establish purpose: You must know the purpose of the forecast. Are you developing a budget for one department? Are you preparing pro forma financials for a prospective lender or investor? Are you estimating staffing needs for a holiday rush?
2. Collect data: You must collect and verify the data. Data collection and data quality are significant issues. Get the best, most recent data available and adjust for any unusual or one-time items. While forecasting involves making predictions about the future, the predictions must be realistic.
3. Develop assumptions: What assumptions are to be made about the data and the other factors that will affect your forecast? You might be testing different price levels, for instance. What is the time period of the forecast? Short-term forecasts are more likely to be accurate than long-term forecasts.
5. Prepare forecast: Once you have determined the method(s), then the actual analysis can begin and the forecast can be prepared. Your forecast will be based on your analysis of the data and any assumptions you have made.
6. Verify and monitor: Once the forecast is completed, the analyst must determine if the forecast is reasonably accurate. The forecast is then monitored and compared to actual results so that any planning adjustments can be made.