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Accounting

Forecasting Demands Effective Scenario Planning


by Chris Howard

Budget modeling could soon incorporate machine learning and other forms of artificial intelligence, allowing CFOs to incorporate global trends into their scenario planning.

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In an economic environment where flux is the norm, forecasting is everything. As CFO, it’s your responsibility to predict the future. Where will the company be next quarter, next year, the next five years, in terms of competitiveness, revenue, expenses and market share? How will trends just beginning to emerge affect the decisions you and your colleagues need to make now?

An accurate forecast is essential, but can be difficult to accomplish, especially if one relies solely on historical information and basic assumptions (e.g. each sales rep brings in $1 million in revenue, so by hiring five additional sales reps we will earn an additional $5 million in revenue in 2019). Obviously, such assumptions are full of flaws. In our example, perhaps it will take up to five months to find, hire and train those sales reps, which means they’re unlikely to fulfill your revenue expectations. 

The point of a forecast is to highlight the opportunities and risks your company will face in the coming quarters, as well as to actualize and support the executive team’s decisions, ideas and planning goals. Certainly, your VP of Sales has a good handle on what’s expected in terms of near-term revenue, and your VP of Operations can predict expenses for the coming year, as long as there are no surprises. 

But there will be surprises – some good, some bad. A product or service can suddenly become red hot, providing your company with an opportunity to gain traction in a market segment it hadn’t been focused on previously. Maybe exploiting that opportunity will bring in millions of dollars of new revenue, but it will also require an upgrade to your fulfillment operations. Should you still hire those five new sales reps? Your forecast will be crucial to arrive at those answers.

Clearly, all risks and opportunities must be quantified. Let’s face it, many of the assumptions we make when planning a budget—are slightly better than gut instincts, but not by much. The decisions your executive team will need to make will be complex; your job will be to quantify how these decisions will impact your company’s P&L, balance sheet and cash flow statements. 

The best way to quantify risks and opportunities is to assess their impact on your cash flow. Hiring five new sales reps and exploiting the mid-tier market can bring in millions of net-new revenue, but what if it takes longer than expected to realize that revenue? Can you count on booking that revenue in time to fund the expansion of your new fulfillment facilities? If not, is a loan required? How will such a loan affect your balance sheet?

Effective scenario planning – or “what if” analysis – requires a highly flexible forecast model that lets you quickly and easily assess the financial impact of business decisions. CFOs have a lot of factors in their favor these days. First, most companies have sophisticated CRM, PEO and other internal systems that house robust data on revenue, HR expenses and so on. This data is practically real time, and can be leveraged to feed your what if scenarios.

CFOs also have the ability to tie their G-Ls to their budget models so that all what if data entered into the model is applied accurately and automatically. This approach can provide you with a forward-looking view of your company’s GL for planning and financial management purposes, allowing you to quickly test multiple scenarios. More than that, because every aspect of the business model automatically conforms to your business, changing it to test the impact of multiple scenarios can be performed in a matter of hours, not days.

Looking ahead, I suspect that within a few years, budget modeling will incorporate machine learning and other forms of artificial intelligence, allowing CFOs to incorporate global trends -- weather, trade -- into your scenario planning. These advances won’t eliminate market flux, but they will allow you to test multiple scenarios with greater confidence.

Chris Howard is vice president of customer experience at Centage.