Tips for improving your financial forecasting output

In partnership with

If you forced me to isolate only 1 priority to manage my FP&A team…

It would be improving my forecast accuracy.

Why?

When you optimize for forecast accuracy, you get so much more thrown in.

But other see the world very different. And that’s okay.

So today’s newsletter we’ll talk about 1) why forecast accuracy is the most important KPI 2) how to incorporate internal drivers and 3) how to identify external forecast drivers…

All in an effort to improve your financial forecast output.

Let’s jump in!

_{Want to be featured in front of over 10,000 finance leaders? Learn more here.}

The best KPI: Forecast Accuracy

To be clear, when I say “forecast accuracy” I am referring to the quantitative measure of how close your forecast for any financial account for any time period is to the actual result.

Here’s a few examples:

• My revenue forecast for January 2024 was +4% higher than actual revenue for that period

• My gross margin % in 2023 was 1.2pp lower than my forecast for the full year

• My salary expense for the Marketing department in July 2024 was $7k lower than my forecast for that period

You can measure forecast accuracy for the next month of actuals (predicting July 2024 revenue on July 13th of 2024) or for any other period.

With those basics out of the way…

When you optimize for forecast accuracy as you primary KPI, you are forced to do a few things:

1. Spend less time producing, editing, and tinkering with reporting

2. Think critically about what drivers influence your forecast the most

3. Spend a lot more time analyzing the operational trends of the business to understand what’s happening and where it’s heading

4. Work with your key stakeholders around the business to understand their tactics and align on forecast expectations

Hopefully you can tell by that list that optimizing for forecast accuracy is less about the forecast accuracy and more about driving the right business outcomes with your forecast.

Sure, there is a very real risk of spending too much time optimizing for forecast accuracy (we discussed the trap of false precision last week).

But when you are clear on what actually impacts your forecast accuracy, then you are far less likely to waste your time on metrics or drivers that don’t matter.

Finally, when you are leading a team of FP&A professionals, distilling everyone’s job into a single KPI (forecast accuracy) means you have a clear vision and focus for your team…

Plus you can make it a competition and celebrate whoever has the best forecast.

Incorporating internal drivers

Now that you’re throwing out all your team goals and focusing only on forecast accuracy for 2025…

It’s time to go after the single most impactful thing for improving your forecast output: internal drivers.

Internal drivers are those metrics or data points that already live inside the business, are predictive of the financial performance, and are readily available for you to incorporate into your forecast.

Here’s a few examples (picking on the Marketing department):

• After studying your HR data for the Marketing department, you know that their FTE turnover rates are at 30% per year for talent sourced from job postings. You also know that they have 1 open posting today and typically it takes 90 days to fill each open posting. Therefore, you are projecting that the Marketing team salary expense will drop by 10% this year unless they hire ahead of attrition.

• As your Marketing team increases the advertising spend next year, your analysis shows that every $100k increase in ad spend yields a 5pp lower return on ad spend. Therefore, you forecast that revenue will increase but at a decreasing rate next year.

How did we come up with these?

Each industry has their own version of internal drivers that influence financial results - and each financial result in your business has a number of drivers (big and small).

Our job as FP&A leaders is to sit down with a blank piece of paper, our key stakeholders, and have a conversation about the customer/product segments and other internal drivers that may impact each financial result.

At the end of the day, our goal is to understand the major drivers of each financial result in the business.

It can only be done with creativity and collaboration.

Identifying external drivers

Every business is driven by 2 macro forces:

1. What’s happening inside the business

2. What’s happening in the marketplace

For startups or hyper-growth companies, it matters far more how the internal operations of the business are leading to growth/profit.

For more established companies, you’ll often find that success comes as the market contracts and expands.

Which means external drivers are more important for established company FP&A teams to identify and incorporate into their forecast process.

My favorite way to find external drivers is to read industry publications.

Let’s make up an example (out of my expertise, so please forgive my ignorance but proves anybody can do this) and show you how to think through it…

We’ll pretend we are a large home contracting company trying to estimate our cost of services for next year.

A major category of our costs are plumbing sub contractors.

A quick internet search (plumbing industry trends) brought me to a number of articles like “Top 10 plumbing industry trends for 2025”.

A particular article by the Farnsworth Group shows the following trends that I can leverage:

• Skilled labor shortage persists (more expensive)

• Consumers seek more eco-friendly and higher-efficiency options (more expensive)

• Smart and connected products are on the rise (more expensive)

A quick scan of these trends tells me that costs are going to get more expensive at faster rate than 2024.

However, when we look at the data (link to chart below) we can see that roughly the % increase in contractor cost for plumbing work is currently (Oct 2024) not growing compared to prior year.

Which means we can probably expect a few percentage points increase in plumbing costs next year based on the research we did earlier - 4% increase feels like a reasonable estimate.

Perfect science? Not even close.
But this sort of analysis is helpful as executives gain trust in your forecast for next year.

In summary:

Forecast accuracy is king.

And there are 2 main ways you can improve it - internal drivers or external drivers.

But at the end of the day, our role is to identify the drivers with the biggest bang for our buck on improving our forecast accuracy.

Say hi 👋 on LinkedIn