One of the most essential contributions an FP&A team can make to an organisation is to participate in the forecasting process. The nature of the business, the sophistication of its leadership, the availability and quality of data and the FP&A team’s capabilities determine whether the team derives forecasts independently, evaluates them as a third party or collaborates with business units to produce the final projections.

Target setting is an equally important task within an organisation However, many companies mistakenly treat forecasts as equivalent to targets — unless they are experiencing rapid growth. This can cause confusion and disappointment within the company, as there are different purposes for both separate tasks.

Forecasts provide management with a realistic outlook on financial performance, cash needs, workforce and supply needs and any gaps in desired performance so that they may develop countermeasures to bridge those gaps.

In contrast, target setting is an aspirational process that defines where management intends to steer the business — indicating the management team’s desire, capability and intent to improve upon current business results.

Before getting into why these two tasks are often misconstrued into the same activity, let’s first take a look at how a best practice FP&A team should support both activities.

Forecasting Best Practice

If a company is good at forward business planning, the best practice will always be either:

Data-Driven Forecasting:

• The business provides well-structured inputs for a predictive financial model.
• The FP&A team facilitates the process, assesses the quality of inputs and ensures the resulting financial projections are reasonable and aligned with the broader business strategy.

Analytical Forecasting:

• In cases where comprehensive data inputs are unavailable, FP&A takes a more hands-on approach.
• The team applies analytical techniques to available inputs to derive a logical and informed financial outlook.

Companies that are not good at forward business planning will likely have the FP&A team derive the entire forecast based on the most recent trends and very little input into what the business plans to do in the forward terms. It goes without saying that any accuracy with this method would only be attributed to the fact that the business is not actually doing anything to change its trend, hence not affecting its business results any differently.

High-performing companies, in contrast, proactively manage their business trajectory. Their management teams develop forward-looking strategies to drive superior results, and their FP&A teams play a central role in leading and participating in the forecasting process. 

Why It Is Essential to Have Business-Derived Forecasts

If a company has FP&A perform their forecasts without much knowledge of any forward-looking business plans, there is now hardly any (maybe none) accountability on the business to perform. Understanding why there are misses in the business or why the business is not progressing becomes impossible. The business will not take ownership of a forecast, let alone a target, because it was not derived from any fact other than a historical trend.

The key to establishing accountability through forecasting in an organisation is to:

1. Mandate that the business owners create detailed, forward-looking plans,
2. What key metrics will they use to measure the effectiveness of that plan, and then
3. When and to what level do they expect those key metrics to perform.

Ensuring these steps are in place is fundamental to producing accurate and actionable financial forecasts. Without this discipline, FP&A’s forecasting efforts risk becoming little more than an exercise in trend projection — providing limited strategic value.

Target setting is like setting the table for the meal, which is forecasting.

Target Setting Best Practice

Much like forecasting, a company may have the FP&A team in a silo, based only on what they superficially know about the business, developing targets that are top-down based on high-level desires of ownership or a management team. Figures like +10% sales, or 10% EBITDA to sales have a nice ring to them — but without business plans to get there have no basis.

Best target-setting practices involve a bottom-up, business-driven plan — developed in collaboration with FP&A and business owners — and a top-down approach based on strategic targets. The goal is to effectively bridge the two, identifying where the bottom-up plan can be optimised and stretched to align with the top-down metrics.

When realistic targets are set based on detailed execution plans, they naturally transition into future forecasting activities. This allows for seamless adjustments in response to changes in operational plans or external factors, such as headwinds or tailwinds.

If targets are never connected to actual detailed business plans, achieving them becomes unlikely, accountability within the organisation diminishes, and the only forecasts that will make any sense will be ones done through a rudimentary trend exercise.

When the Lines between Target Setting and Forecasting Blur

When a business is underperforming, no one is happy with its current trajectory. If the results are so far off the original targets set, it renders those targets irrelevant.

In such cases, simply forecasting based on current trends will not be acceptable to management or ownership. Instead, the business must be challenged with new, more relevant targets — ones that align with the current trajectory while still driving meaningful improvement.

A common mistake many companies make in this situation is not understanding that there should always be 2 versions of a forecast in this situation. One should reflect the worst-case scenario — typically a continuation of the current trend — while the other should represent a realistic yet challenging plan to break the trend and drive improvement. Management or ownership teams can then take these 2 versions and adapt their future expectations based on their confidence in which plan is more likely. Maybe a blend of certain aspects between both.

Less experienced FP&A teams often struggle by blurring the distinction between the target-setting forecast and the worst-case scenario projection. High-performing FP&A teams will work with the business partners and understand their business enough to push their partners in the right areas to pursue the best possible results and reflect the worst-case scenario where they do not see adequate plans.

In many instances, they may refer to this as an internal or stretch plan — the primary plan used for collaboration with business partners — while a worst-case scenario is reserved for management and ownership teams. Relying on only one version of the forecast or target or making the business aware of a lower, potentially acceptable version increases the risk of disappointment and failure.

Using External Inputs in Developing Targets and/or Forecasts

Any high performing team should be thinking about all factors affecting their results, both internal and external. However, the quality and completeness of information often make it difficult to fit into a data model or a forecast process. All that being true, best practice would be to develop more and more ways to cultivate and use this external information to inform forecasts and target setting.

The more relevant data you can consider in these two activities, the better the quality of the output will be.

We have covered a fair number of concepts within target setting and forecasting in this article. When developing financial projections, organisations must clearly define their objective: what are they looking for when developing numbers? What is the purpose? Is it to set a new target for the business to strive for, or is it to give the most realistic expectation of future results based on past trajectory? Management teams should align their expectations accordingly, ensuring the numbers reflect the intended purpose. Whichever the purpose is, incorporating both a stretch scenario and a worst-case scenario provides a well-rounded perspective, offering a realistic range of potential business performance.