Jaime Medina
Forecasting is one of the most critical functions within a financial department. Bookkeeping and accounting focus on verifying past and present numbers, providing the foundation for projecting the future and avoiding tax and legal issues. However, the CFO’s biggest value often lies in predicting what will happen in the coming years. While this is a useful exercise, it also carries significant risks.
The first common mistake while forecasting is assuming that reality will follow exactly what’s laid out in an Excel sheet. Anyone can create a spreadsheet that makes a project look highly profitable on paper. We often see entrepreneurs making unrealistic assumptions, like deciding that a KPI, which has been flat for the past three years, will suddenly improve by 50% starting next month. This is a form of wishful thinking. Business momentum typically follows past trends. While these trends can certainly change, it requires associated investment or spending. For example, if a company wants to sell 50 new accounts per month instead of 20, there needs to be an actionable plan behind that jump.
The second risk is believing that everything can be captured in an Excel sheet. This is a common trap for finance professionals, whose work revolves around numbers. However, a business is influenced by market trends, qualitative behaviors, cultural differences across regions, and more… These factors cannot be quantified in a spreadsheet. Product improvements, for instance, often depend on customer attitudes, which are difficult to predict using purely quantitative methods.
The third major pitfall, as Nassim Taleb would say, is ignoring black swans, those completely unexpected events that can radically change the direction of a business. No forecast in 2018 or 2019 accounted for COVID-19 hitting in 2020, which is understandable. But we should remember that unforeseen crisis can always come. Therefore, businesses must not only project a solid forecast under normal conditions but also be reasonably resilient in extreme situations.
Of course, forecasting isn’t completely useless. It’s not all bad news! It can work wonders when done right. We, in fact, make a living partly by creating solid forecasts! They are one of the most powerful tools for shaping business strategy and assessing the validity of hypotheses. In our next article, we’ll dive deeper into the wonders of forecasting.
