A financial model that moves forward one month at a time
A financial model that moves forward one month at a time
A rolling forecast is a type of financial model that predicts the future performance of a business over a continuous period based, on historical data. Unlike static budgets that forecast the future for a fixed time frame, e.g., January to December, a rolling forecast is regularly updated throughout the year to reflect any changes as time goes on. That is, it relies on an add/drop approach to forecasting that drops a month/period as it passes and adds a new month/period automatically. It allows companies to predict the future based on recent numbers and time frame since they operate in a fluid and ever-changing business environment.
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While most traditional businesses use static budgets, a rolling forecast provides more benefits to rapidly growing and large companies. On the other hand, with static budgets, the budget remains fixed and does not change as the business evolves. As a result, even if revenues exceed budget estimates, the static budget will remain until the predetermined time frame.
With rolling forecasts, businesses establish a set of periods after which to update the forecast. For example, if the company sets the period to a month, the budget is automatically added one month after every month is complete. It allows businesses to regularly adapt their budgets to reflect recent trends and changes in the industry.
The process of creating a rolling forecast should be done in a sequential order to avoid missing some steps. The process of creating forecasts is as follows:
The team tasked with creating the rolling forecast should keep the end goal in mind when building the projections. Setting the objectives also involves identifying the usability of the forecasts and the persons who will rely on the forecast to make decisions. Failure to set clear goals from the start will inhibit the process of creating rolling forecasts.
A business must keep the time frame of rolling forecasts in mind to help in planning. It involves deciding on how far into the future the forecast will go. The business should determine the forecasted increments in advance. For example, a company may choose the increment period to be weekly, monthly or quarterly. If management chooses monthly increments for 12 months, after one month is traded, it drops out of the forecast and an extra month is added to the end of the forecast. It means that the business is forecasting 12 monthly periods into the future as shown in Figure 1 below.
The length of the forecast period may determine how much details should be included in the forecast. Ideally, longer forecasts will be less detailed, but they will need to be regularly updated. Also, where the consequences of a bad decision are large, the creators of the rolling forecast should spend more time and effort to increase the accuracy of the forecasts. It should be noted that longer forecasts require fewer details and therefore, are less accurate than short time frame forecasts.
A company must identify the key contributors to the process of creating rolling forecasts. The participants need to be persons who are objective, unbiased and insightful to make meaningful contributions to the process. They should be rewarded when the company achieves the set targets and held accountable when the company fails to meet the targeted performance.
Rather than focus on all aspects of the business, the company should identify the value drivers where it is more likely to achieve success. Focusing on too many goals may obstruct the company from achieving the objectives that are more important to its success. The value drivers may be identified from the past company successes from the industry in which the business operates.
The data that the company relies on when creating the rolling forecast should be reliable and credible to give objective targets. The management must verify that the quality of data is above par and that the source of the data is trustworthy.
An essential step in creating rolling forecasts is assessing the possible financial outcomes using certain assumptions and drivers. It gives the company a glimpse of the possible scenarios depending on the drivers that the company uses. As new information becomes available or new trends appear, the forecast can be updated, and new outcomes ascertained. The scenarios and sensitivities help the company make better decisions.
Once the rolling forecast has been implemented, it should be tracked to see if there are any variances between the actual performance and the set targets. If there are any variances, the participants in the process should find out what led to the variances and plan the courses of action to remedy the situation.
Learn more in CFI’s Rolling Forecast Modeling Course.
A company that uses a rolling forecast as opposed to a static budget enjoys the following benefits:
Businesses operate in an ever-changing environment, which translates to increased risks. By using a rolling forecast, a business can continually adapt to the changing economic and industry conditions, which helps reduce the amount of risk exposure. Additionally, the company can identify areas that need more attention and allocate more time and resources to them.
When preparing annual budgets, large businesses often need to consider various variables that keep on changing every day. For example, the implementation of a government policy that directly affects the business will require the company to adjust its financials to accommodate the changes. If the business relies on a static budget, it will need to wait until the next budgeting period to reflect the changes. However, with a rolling forecast, it is regularly updated to reflect any changes that affect the company’s financial plan. The practice makes it more reliable and realistic than a static budget.
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