No discussion of forecasting would be complete without some back handed comparisons to those people who actually make their living by forecasting, namely weather forecasters. There are others that also can be said to make their livings this way. People who are in the stock or commodity markets are in effect forecasting the upward or downward movements of prices in the markets based on whether they buy or sell at any specific time. But when it comes to forecasters, it is the weatherman that everyone immediately thinks of. Believe it or not this idea fits into my general business and sales approach to topics. I think it is pretty apparent that if you forecast in business as accurately as weather-people (need to be politically correct here) forecast the weather, you won’t be in business very long.
I heard a great weather-person related joke the other day. It goes:
When I die I want the television weather-person to be the one that lowers my casket into the grave. That way they can let me down one last time.
To be honest it has been a challenging period for weather forecasters here in Texas. Probably not so much in the other parts of the country. Elsewhere in the country it seems that any forecast that contains the words “cold” and “snow” has at least a reasonable chance of being correct. Here in the last week we have had sunny warm spring like days, rain, sleet, ice (yes ice, they immediately shut the entire state down when anyone anywhere in the state gets ice) and snow. Sometimes we have had multiple selections on the same day. We have had almost fifty degree temperature swings between the sunny warm highs and the snowy cold lows in just two days. Still, you would think that based on either the officially certified coin flipping or dart throwing weather predicting process that appears to be used, that the laws of probability and statistics would have to take over at some point and they would get at least one forecast right.
It is against this publicly recognized futility in forecast accuracy that we need to look at forecasting within the business environment.
Successful business is predicated on properly setting expectations. If you set your customer’s expectations properly, and then meet them, they will be satisfied. We all know that a satisfied customer is a good thing. If you set the stock analysts’ and business press’ expectations about how the business will perform, and then meet them, the price of your stock will probably go up. We all know that an increasing stock price is also a good thing. If you set the expectation with management regarding the performance of your business, and then you meet it, you will probably get to keep your job and may even be asked to take on more responsibility. Keeping your job is also a pretty good thing.
Setting expectations is also known as forecasting. It leads to a thing called “predictability”. Predictability is usually a desirable thing in business.
Good business forecasting is all about breaking down the complex (in this instance, “the business”) into its component pieces (such as “revenue”, and “costs” and things like that) and working the individual forecast for each one. You can then combine these individual forecasts into the overall business forecasts.
It also provides you an excellent insight into which specific components may need to be looked at for potential adjustments should the total forecast not meet what may be considered acceptable levels of expectation by management.
Expectations are funny things. They can cut both ways. Businesses usually want to set expectations that are difficult but achievable with senior management. Senior management usually wants to set the expectation that it requires more from the business than the obviously easily obtainable expectations that they are currently being provided. Senior management will then in turn try to set expectations for the overall business performance with the analysts and market that are believable, and the analysts and market will decided whether or not they will believe them.
This all takes us back to forecasting. Expectations are set with management through the use of forecasts. There are forecasts for revenue. There are forecasts for costs. And then there are the resulting forecasts for margin or earnings. Hopefully there is a relationship between the revenue and the cost forecasts so that margin and earnings can in fact be realized.
As an example of forecasting, in Texas you know that in May it is going to start getting hot. By June it will be hot. It will probably stay hot until September and that by October it might start to not be so hot. This is known as “Climate”. In general you can expect this. You can look at historical averages and trends and see what the various highs, lows and precipitation were for specific days, but you don’t know what they will be this year. That specificity is known as the weather.
The closer you get to any specific date, the more accurate your forecast can and should be for that dates weather.
The same should apply for businesses. At the beginning of the year there is a general expectation of what the “climate” should be for any specific business. This is based on past performance and the desires for growth (or contraction) in the component markets and businesses. As data comes in and performance evolves the forecast for any specific piece of the business will begin to come more and more into better focus. Unexpected events and unforeseen issues can always occur and cause the accuracy of the forecast to change, but in general, the closer you get to a specific date, or target, the more accurate you should expect the forecast to be.
The key here is that the forecasts should always be based on the factual data. If it has been cold and snowy in the northeast for the last few weeks, and there are still several feet of snow on the ground, then no matter how badly senior management would like to see sunny, spring like temperatures it is probably best to stay with reality. Understanding the business equivalent of “in the summer it’s hot and in the winter its cold”, regardless of the specific day to day variations, is an important aspect of accurate forecasting.
Forecasts are designed to inform people of what they need to know and hear, not what they want to know and hear. They are keys to setting expectations of the business’ performance and targeting areas for attention when expected performance does not meet the business needs. When a forecast is missed it will have a ripple effect throughout the business.
When a weather forecaster misses a forecast there is a possibility that someone may get wet when they thought they would be dry, or they may be cold when they dressed for warmer weather. When a business misses a forecast the financial performance of the entire organization can be brought into doubt. This usually results in actions that must be taken to bring the financial performance back in line with expectations. These actions can usually be distilled down to one of two things: increasing revenue or decreasing costs.
The need for decreasing costs is never a fun forecast for the people in a business.