Business Magazine

Why Budget Forecasts Are Always Wrong

Posted on the 25 February 2011 by Alanhargreaves @RechargeToday

Has anyone ever produced a budget that turned out to be right?

I haven’t. Even where the bottom line ended up roughly where I forecast it should be, it got there via an entirely different route to the way my spreadsheet got there.

Take breeding horses. That’s something I do as a commercial hobby. It’s not meant to make a lot of money. It’s more of a lifestyle thing – but it’s not meant to lose money either.

I started my breeding program over a decade ago. It ticks over OK, but not in the way I planned. Yearling prices go up and down regardless of the quality of my pedigree planning. Prices have been entirely unpredictable.

No one forecast the equine flu epidemic, which quarantined my broodmares and meant I couldn’t breed anything that year.

Stallions go in and out of favour. It’s a good year when I’ve got offspring from the popular ones; not so good the other way around.

And that’s all before I have factored in the Australian dollar for overseas demand, paddock accidents and vet costs, plus the performance of past progeny –  just to mention a few other variables.

This all about business risk. You can’t eliminate it. You can only manage it, and you can only make robust forecasts if you constantly stress test your assumptions accordingly.

The spreadsheet I put together ten years ago makes embarrassing reading now. I still produce them today, but now I do it in triplicate: best, worst and most likely. Even then I usually test out what would happen if everything was 20% lower.

Some years the best is the nearest; other years it’s the worst. But over time there is a trend line that is getting close to the most likely. Not on it, but near it.

What does all that tell me?

Probably the obvious. At the start-up stage, the chances of your forecasts being in the ball park are slim. There is just too much you haven’t thought about and that you won’t find out about until you are on the road.

What can you do about it?

If you are looking at starting a business or a new project, examine every income and expense item and stress-test it for risk. This is a cash flow exercise, not a profit forecast. It’s about survival. Make sure you are realistic about receiving money. Don’t count invoices; count the money you expect to actually receive, and when. Forecast both late payers and non payers.

Look at seasonal shifts in revenue and costs. Check that you will have enough money at the right time. What if your best customer went broke? What if a supplier did? You might choose to ignore the unforecastable – like fire, flood or earthquakes. But given the last 12 months, maybe you should at least have a think about them.

If you are just starting out on an idea and don’t know much about spreadsheets, go to the Reboot Workshop and download the Cashflow Budget.

Fiddle around with it. You will soon see where your leverage is, and isn’t. These are the critical things you’ll have to get right – or change your strategy. This is the value of the budgeting exercise. The goal is not to produce a result that matches reality. It is to focus on the critical path you must take and what elements have the biggest impact on the outcome.

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