Generically, forecasting is about planning the Profit and Loss statement (P&L) for a defined upcoming period. Letting budgets and mid-term or long-term business plans aside, most practitioners consider a full calendar year (CY) or an x-month rolling (e.g. 12MR) period for their forecast scope. Depending on the organisation type subject to forecast and the overall enterprise structure, the forecast scope can encompass the full P&L or a portion of it. Logically, the key performance indicators on which most forecasting attention is placed should be the ones reflecting where the managers of the Reporting Organisation have the highest influence.

In practice, these definitions can become secondary to the question of how much truth, message or even political content a forecast can – or has to – convey: in short, how much managerial courage it takes to deliver a forecast. Certainly, it depends on who the Reporting Organisation and the Consolidating Organisation are. I find the forecasting situation of a Reporting Unit with responsibility for local sales, production or service the one where the question about message and courage in the forecast is arising with the most tension since it is located in the heart of the overall Enterprise. The Local Unit aggregates the operational business results it is responsible for and delivers the result to a Mother Organisation, which can be a Regional Organisation, a Company Division, a Corporate Function, or the Corporation itself. It is also subject to the level of expectation placed by the Mother Organisation.

A Forecast Is an Act of Truth

Fundamentally, forecasting a P&L is about estimating revenues of sales, costs of goods sold, and SG&A costs (selling, general and administrative expenses) for the upcoming period. At first glance, a tempting and apparently time-saving approach for the Organisation might look like a summarised P&L for the forecast period based on the estimation of a few KPIs done by the Finance Department. A rather recommendable and common approach is, however, a more detailed P&L elaboration, reflecting fact-based past experience, the best available knowledge and the soundest assessment of future environment and business development.

Thereby, the forecast should not be the sole work of the Finance department of the Reporting Organisation, for it may not have all elements available to make its own assessment of the business development. Furthermore, it should be the result of a joined teamwork encompassing, additionally, the managers of sales, operations, human resources, purchasing and supply chain, with the sign-off from the general management. Further, a forecast as a bottom-up exercise considers market conditions and customer demand, production capacities and machine requirements, human capital situation, prices and availability of material and supplies. The purpose of this enumeration is not to make an exhausting parameters list but rather to reinforce that the view on these parameters should be consistent and agreed upon between the managers of the Reporting Organisation. For instance, there is little value in reflecting a sales level based on customer requirements when a bottleneck may arise in the availability of necessary machinery. Equally, a forecast inconsistency may result from workforce planning based on hiring requisitions issued to secure the workforce when an expected production fluctuation may suggest the necessity of reducing the number of hours worked for the next time.

After this effort, a forecast aims (or should aim) to tell the truth about the evaluated parameters and provide an honest view of their expected development. In this sense, the forecast is a realistic exercise.

A Forecast Is a Message

Change lies in the nature of Rolling Forecast and calendar year outlook. At each month's end, actuals replace expectations on all P&L lines, deviations occur, and trends are gradually revealed. The need to deliver a realistic forecast calls for an upward or downward reassessment of the P&L for the overall forecast period based on actual variance, with a more or less significant variance level for the overall forecasted period. The question comes up: how much of the past month's variance should be reflected in the total forecast period, i.e. shown as performance, and how much should be absorbed, i.e. retimed? I have come across enterprises or organisations within the same company, where a fluctuating forecast and a stable forecast from the Reporting Organisation are differently received by the Consolidating Organisation.

Some Consolidating Organisations perceive a fluctuating forecast as an honest approach. Their expectation towards Reporting Organisations is to receive the best of their knowledge and anticipations for the future period, to consolidate the truest picture of the overall perimeter and see to what extent positive and negative variances can compensate by themselves. They also see it as their role to manage the resulting favourable or unfavourable total variance and decide to which extent they should maintain or adjust their forecast to the next organisation level in the company.

Other Consolidating Organisations perceive a fluctuating forecast as a lack of self-confidence from their Reporting Organisations and view stable forecasts as a sign of reliability. They expect the local Units to manage the fluctuations by themselves and to adjust the forecast only when enough facts are accumulated so that the magnitude of the necessary change makes it worth revising the numbers.

While the latter approach suggests a higher level of responsibility for the Reporting Organisations compared to the former, it requires a high degree of maturity from the Reporting Organisations, regarding the actual data transparency from the ERP system, the planning ability of the controllers, and the availability of an adequate forecasting tool. These conditions are key to making Reporting Organisations able to forecast bottom-up, calculate scenarios, and assess financial up- and downsides resulting from possible sales and cost driver developments.

Besides the necessary conditions to make this approach a sustainable one, the expectation of stability in the reported forecast, placed by Consolidating Organisations, can influence the forecast content or message delivered by the Reporting Organisations, depending on several factors: whether Reporting Unit managers are optimistic or conservative nature, whether the actual situation suggests an up- or downside for the forecast period compared to budget, and depending on the point in time in the calendar year.

A Forecast Is a Situational Behaviour

Several moments in the calendar year can be considered determining to assessment of the content or the message conveyed by a forecast: the early start of the year, the middle of the first half (H1), the budgeting timeframe and the very last forecast rounds in the year.

A conservative Reporting Unit is likely to show prudence right at the beginning of the year. In an unfavourable current situation compared to budget, this prudence may result in an early forecast drop below budget and potentially in another drop during H1. In a favourable actual situation, prudence may be shown by keeping the forecast at the budget level and maintaining this level as long as possible. When the time comes to establish next year’s budget, the Consolidating Organisation will likely feel the need to push for some prudence release, calling it at times “sandbagging” elimination. How much was adequate prudence and how much was exaggerated will come out during the latter part of the year, along with the judgement capacity from the Consolidating Organisation.

The optimistic nature of a Reporting Unit is likely revealed in an unfavourable actual situation vs budget by maintaining the budget level for quite some time, thereby delivering the message of the ability to compensate the accumulated gap during the rest of the year by actions on sales and/or cost. A moment of truth is the timeframe before budget: In order to set a realistic starting point for next year’s budget, it should sound logical to release part of the forecast risk at this time. This may be perceived by the Consolidating Organisation as a kind of “sandbagging” to build next year’s budget, which is likely to oppose or show some resistance to a reduction at this time. It then takes managerial courage from a Reporting Unit to go for a forecast reduction. On the other side, pursuing too far in the year on a too high level probably does not make the discussion easier when the forecast must badly be reduced: The closer yearend approaches, the more Consolidating Organisations perceive forecast reductions as bad surprises and can interpret them as a lack of reliability from the Reporting Units. So it appears important for a Reporting Unit to seize the right moment for a forecast reduction and to show courage by releasing the risk to the highest extent at once since the alternative - a gradual risk release late in the year - may be received by the Consolidating Organisation as a “sausage cutting” approach and may worsen the mistrust feeling.

The situation of an optimistic Reporting Unit in a favourable financial situation vs. budget may at first appear ideal since a forecast increase can take place early in the year and may be reinforced a few months later. This situation, however, bears the risk of over-judging the forecast period and should call the Consolidating Organisation for prudence, at the latest at the budgeting timeframe, to avoid building next year’s budget on an over-optimistic starting point. Such a budget may result in problems reaching it during the following year, especially if the conjuncture happens to cool down.

Conclusion: Towards a Forecast Culture

Considering forecasting as an exercise to assess future financial performance as accurately as possible through a bottom-up approach based on actual facts, it appears necessary for an Organisation to become conscious of its own culture.

For a Consolidating Unit, it seems necessary to identify the prudent or optimistic nature of Local Unit managers and accordingly interpret the message behind the reported numbers, depending on how challenging the situation of the Unit vs budget is. Equally, it seems advisable to foster a culture of trust where Reporting Units are encouraged to tell the truth and avoid inducing Units to deliver opportunistic or even politically driven forecasts. For a Reporting Unit, it appears necessary to understand the expectations placed by the Consolidating Organisation, i.e., to what extent forecast fluctuation or forecast stability is being appreciated. It equally takes managerial courage to keep optimism in a forecast so as to deliver bad news at the right point in time.

A clear discussion between the involved units is advisable, related to which level of the organisation is expected to manage the financial risk and up to which amount. Equally, an ongoing evaluation of up- and downsides (risks and opportunities) vs the delivered forecast numbers on sales and cost is an advisable practice so that quantified scenarios are available and a consensus can be reached about how to best reflect the financial performance of the overall Organisation throughout the year, in favourable as in challenging current situation.