Financial Forecasting: Why it Matters
Forecasting is one of the most crucial activities that organizations frequently conduct. Forecasts can be operational or financial, and in most cases, they are interdependent.
Even though we have all heard phrases such as, “Stay on plan!” or “Don’t be way off the last forecast,” the reality is that finance and accounting professionals jump into forecasting as soon as the official finance close is over.
And their forecasting variance vs. actual results is typically low — based on an average over the last five years, forecasting variance is, in most cases, less than 5%.
But unexpected events can send those variances off course.
Why Financial Forecasting is Essential
When we look at companies that let go of employees in large numbers or have filed for bankruptcy during the coronavirus pandemic, they all suffered a revenue loss of somewhere between 50-100% in a matter of two to three months.
Hertz is an extreme example where catastrophic revenue loss combined with an unsustainable debt situation resulted in bankruptcy. The collateralized asset-backed securities made things worse.
The critical question becomes how we can become more comfortable with extreme variations between different versions of the same forecast. Understanding variations will prepare us as we think about making structural changes (capital structure, human resources, new businesses, etc.), which will act as a defense in our contingency plan.
The next step is to think about potential catalysts that could trigger a chain of events leading to severe financial losses and, in the worst-case, bankruptcy.
These triggers will be a very industry-specific exercise, with assumptions based on research and advances in science, technology, or history. We can also assign timelines to make it easier to prioritize.
Examples of potential catalysts of financial losses:
- Medical Insurance Industry: A new drug is discovered that extends human life by 30% and increases the immunity level by 20%.
- Auto Repair and Insurance: Self-driving electric cars get government approval in major Western markets. The need for car repairs/maintenance and incidents of road accidents decrease by 70%.
- Food Production and Animal Husbandry: A rare disease outbreak takes place. Governments place a ban on certain meat processing for a year.
- Aerospace and Airlines: Supersonic jets receive FAA approval, and Virgin Atlantic launches low-cost intercontinental flights that reduce flight time by over 60%.
Though this type of forecasting may seem outlandish on its surface, it is something we start to spend more time and consideration on when we go through major, transformative events like the coronavirus pandemic.
Sometimes, it doesn’t hurt to think through the potential black swans to help us prepare as best we can.
Need Forecasting Support?
DLC’s dedicated team of consulting professionals is here to help you navigate this dynamic landscape from revamping your business strategy to executing essential finance and cash management initiatives.
Contact us today or click on the link below to learn more about our FP&A support services.