Effective Forecasting via Planning

Revenue and expense forecasts and actuals are the most reviewed performance measurements of a company. However, an effective planning exercise should focus most time and effort on fundamentals – strategy, underlying initiatives, and investments that directly dovetail with the operational impact of those initiatives. If done well, such a planning exercise will allow for a direct link between operational behaviors and financial forecasts.

History is only a good predictor of the future if the same conditions repeat. Where rapid-growth companies are concerned, operational behaviors should be changing drastically, and the market is likely shifting quickly. So, forecasting future financial performance by extrapolating past performance is either an inaccurate reflection of real growth prospects, or a company-level admittance that strategy and operations are not positively evolving to drive further growth. This is a very important growth consideration because inaccurate forecasts put senior executives on the back foot and forces the company into a reactive mindset, potentially derailing company’s forward momentum.

Simplifying heavily, a financial plan covers three aspects – revenue, expenses, and cash flow, the last of which is firmly in the Chief Financial Officer’s (CFO) realm and I won’t discuss it. Without overstepping into the CFO’s world of financial planning, it is critical to address the relationship between strategy and operations, and revenue and expense components of the financial plan.

Two specific outcomes of the planning exercise can provide all necessary strategic and operational inputs to develop the revenue and expense forecast: 1) Initiative-Resource Map, and 2) Leading Indicator Map. Both of these deliverables were introduced earlier under the Planning Outcomes chapter.

Expense Forecasting

Let’s start on the expense side because growing a small- to mid-sized company is a pay-to-play equation. A company has to first decide what it can afford to work on before the results of that work is revealed. Trying to decide revenue targets first and working backwards to the cost of achieving that revenue is risky because the company is anchoring itself to aspirational revenue goals and likely allowing biases creep into what various investments are truly capable of delivering.

Overhead ‘Fixed’ Resource Expenses

As discussed under Efficient Organizations, a small- to mid-sized company can categorize its resources (people, equipment, and technology) into two components. These two resource categories drive all operating expenses at the company. Although I am consistently framing employees as resources below for simplicity, the planning team should consider non-employee resources such as technology as well. The Initiative-Resource Map, which is one of the six key deliverables of a strategic plan, should lay out every single Overhead ‘Fixed’ Resource that will be deployed at the company during the planning period.

The illustrative view above shows the concept behind an Initiative-Resource Map. The high-level steps to develop and leverage an Initiative-Resource Map are:

  • First, all strategic initiatives proposed during planning are mapped against existing Overhead ‘Fixed’ Resources. For simplicity, this illustration does not show time as a factor. In practice, time should be added in to appropriately load resources. This essentially, gives the company a view of what can be achieved with existing (i.e. baseline) investment. Similarly, the planning team of a somewhat larger company with higher employee counts can group very similar employees into one resource. If the company has three technical resources with the same skillset of managing Salesforce (a Customer Relationship Management software), this can be one resource with a capacity of 3 FTEs. I recommend that the planning team make such adjustments to ensure that the company is reflected adequately without making the exercise unwieldy.

  • Secondly, additional resources (incremental investment) can be proposed to complete other top priority strategic initiatives. This provides the expense increase forecasted from Overhead ‘Fixed’ Resources.

  • Third, planning is an opportunity to assess the need to up-skill an organization. This mapping exercise offers an opportunity to introspect whether existing and proposed resources are truly mapped to well-vetted strategic initiatives. It allows the company to consider reallocating existing investment on Overhead Resources elsewhere or decide not to approve proposed Overhead “Fixed” Resources that are not effectively mapped to major longer-term strategic initiatives. i.e. protect the company from overstaffing.

  • Lastly, the Initiative-Resource Map returns productivity improvements that can be expected from Frontline ‘Variable’ Resources, which feeds the Leading Indicator Map (see below).

Self-reflection about under-skilled existing resources and rejection of under-vetted proposed investment is a key necessity of strategic planning. Cash-rich, small- to mid-sized companies can be tempted to add resources without removing unneeded resources or rejecting nebulous proposals. Overstaffing and padding middle layers of the company with supervisors or acquiring equipment and technology with a low return on investment can be avoided through this systematic approach. The Initiative-Resource Map provides a rational and structured approach to ensure the company remains lean and efficient.

Once all the steps above are complete, the Initiative-Resource Map directly returns a forecast for Overhead ‘Fixed’ Resources. This directly feeds the expense side of the financial forecast after overlaying the market price for these resources (fully loaded cost for compensation, technology licensing cost, equipment purchase cost, etc.).

Frontline ‘Variable’ Resource Expenses

Everything we discussed so far in strategic planning covers how a company can improve its maturity level and productivity and align closer to market needs. At the end of the day, a company needs to put together its products and services and sell or deliver its offerings to customers. Frontline ‘Variable’ Resources form the factory side of the business.

Every company is different, and the specific bucketing of resources will differ. Generally speaking, activities that contribute to building, selling, and delivering offerings, billings, collections, etc. can all be generally classified under this group. Strategic planning must first forecast the expenses associated with Frontline ‘Variable’ Resources. This forecast will lead us to the revenue target achievable (selling resources fall in this category) and product and service timelines possible (creators and deliverers of offerings also fall in this category).

Resourcing in this category should be based on operational performance of Frontline Resources, quantified by leading indicators. A Leading Indicator Map is a framework that provides a method to assess the quantifiable organizational value that each Frontline Resource can drive and, thereby, assess incremental Frontline Resource needs. The visual below provides an illustrative view of the components of a Leading Indicator Map.

  • Component 1: Using this framework allows the planning team to comprehensively list all leading indicators that measure the operational performance of relevant Frontline ‘Variable’ Resources in one location. Such a listing allows the team to create a company-level view of leading indicators and avoid metrics and targets that conflict with each other. Additionally, these should be the same metrics that are used to assess performance of these roles as we discussed in the leadership approach section.
  • Component 2: A baseline (current benchmark) measurement of each leading indicator is necessary to level-set what various resources are currently capable of delivering. This baseline should align with current overall company performance and should not include aspirational or what-if scenarios. If no strategic initiatives are executed effectively to improve productivity or maturity of operations, this baseline is all the company should expect from these resources during the planning period.
  • Component 3: Strategic planning allows an opportunity to improve this baseline performance by optimizing operational productivity and maturity through prioritized strategic initiatives in the Initiative-Resource Map. These improvements should be reflected in target performance levels slated to kick-in at various times during the planning period when associated strategic initiatives are successfully completed.
  • Component 4: Lastly, the company has to decide whether incremental Frontline ‘Variable’ Resources should be invested in. If a company is unable to improve operational productivity, which is reflected as difference between baseline and target performance, and yet chooses to add additional Frontline Resources, it is equivalent to scaling linearly (i.e. throwing money at the problem).

The Leading Indicator Map offers the company a structured path to decide whether it should invest further in Frontline Resources, and when those investments should be triggered based on operational performance improvements targeted through strategic initiatives. This tool directly provides the overall expense forecast from Frontline ‘Variable’ Resources.

Revenue Forecasting

Revenue forecasting is the easiest part of the whole exercise if all other components are effectively developed. Simplistically, revenue is the output an organization can generate based on the input – its investment into resources – and the process – the strategy and operations to convert that investment to revenue. The revenue forecast for an organization can be modeled directly from the factors identified in the Leading Indicator Map.

Revenue forecast is a relatively simple calculus, after adjusting for the timing of productivity improvements and hiring of Frontline ‘Variable’ Resources. It can be stated as:

Target measurements of leading indicators associated with revenue generating Frontline ‘Variable’ Resources
(translated to $ metrics)

Multiplied By

Number of existing Frontline ‘Variable’ Resources
Number of incremental Frontline ‘Variable’ Resources

If this view seems overtly simplistic, it is the silver lining associated with a focus on the fundamentals – Strategy and Operations. Poorly executed strategic planning efforts often spend significant amounts of time and effort on revenue and expense calculations; then, when the company goes on to miss those forecasts on the high or low end, there is little clarity on the root cause. A forecasting exercise that is focused on the company’s fundamentals remedies this issue.

Although financial forecasts are a critical outcome, it can be a relatively seamless output of a strategic planning effort that focuses on the treasure hidden all along the path of the planning process.

Published By

John Oommen

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