Does forecast accuracy matter?

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If you want to start the nerdiest debate in the history of the world…

Post the following on LinkedIn:

Forecast accuracy is the most important KPI for a finance team.

You’ll quickly divide the crowd between those who believe it and those who think forecast accuracy is a waste of time.

How can both be true?

And why should you even care?

Let’s jump in:

What is forecast accuracy?

Just like a weather forecast, a financial forecast attempts to predict the future based on data inputs, fancy models, and expert intelligence.

The further in the future you can accurately predict, the more valuable your forecast will be.

And there are 2 main measures of forecast accuracy that I obsess over:

1. Current month

2. Full year

Your current month forecast is simply trying to predict the financial performance of the month you are currently in.

If today’s date is 6/15/24, then we are predicting how June 2024 financials will look when the books are closed.

Your full year forecast is trying to predict the financial performance of the full year that we are currently in.

If today’s date is still 6/15/24, then we are trying to predict how Jan-Dec 2024 will look when the full year has ended. This means we already know for certain how Jan-May 2024 looks (Year to Date, YTD) but don’t know Jun-Dec 2024 (Rest of Year, ROY).

And measuring forecast accuracy is as simple as comparing what you expected the financial result to be versus what actually happened.

If you expected June 2024 revenue to be $500 but it actually resulted in $505, then your forecast was off by 1%.

When evaluating your current month forecast accuracy, your goal is to improve the % variance every month (more on this later)

And when measuring forecast accuracy for the full year, you would expect your forecast accuracy to get better every month as you move towards the year - November forecast for 2024 year end should be more accurate than the February forecast for 2024 because there are fewer months where we don’t have actuals.

Why does forecast accuracy matter?

In the last 2 weeks newsletters, we’ve been knee-deep in financial forecast best practices, this is week 3 of that series.

And the last 2 weeks I’ve explained 1. how to develop driver based forecasting and 2. how to drive forecast ownership to your business partners.

Both of these lessons assume that a forecast is an important tool for the business and that finance is best equipped to wield that tool.

How did I come to these conclusions?

In itself, forecast accuracy doesn’t actually matter.

Instead, it’s a means to an important end.

It unlocks better and more confident business decisions. Which allows finance to drive meaningful discussions about business resources and the best use of them.

A bad forecast means the business will default to operating on gut-feel rather than data driven decisions.

Talk to small business owners who are looking at their P&L and wondering if they can afford a large purchase. You’ll quickly find how important a forecast (and an accurate one) is to a business leader when everything is unclear.

Play that forward to a business leader who has 8 department heads reporting to them who each have 100’s of people working for them. Now a forecast is an essential tool to quickly know the expected financial outcomes in the future.

How to measure forecast accuracy:

If you aren’t currently measuring forecast accuracy or want to make sure your process is solid, here’s how I would do it:

1. Schedule a forecast review meeting

2. Create a simple excel tracker

3. Make it a game

1. Schedule a forecast review meeting

What gets calendared gets remembered.

Do yourself a favor and schedule a forecast review meeting right now with your team (or your manager) on a monthly basis.

The intent of those meetings is simply to go through your entire forecast and study which picks are solid, which you aren’t sure about, and which ones keep missing and you have no idea how to fix them.

It’s your chance to take a step back and ensure you feel confident in the picks you are making so that your CFO can feel confident in the output.

Earlier this week I published a video walkthrough of my forecast review meeting structure in the Finance Leadership Lab. Check it out here.

2. Create a simple excel tracker

No need to overcomplicate it.

Pick the most important forecast metrics for you (Revenue, COGS, OpEx) and plan on measuring the same ones each month.

You can go down to the driver level (sales, customer inquiries, interest rates, etc.) especially for your most critical drivers, but I’d recommend starting high-level before diving down. Let the data tell you where your forecast isn’t accurate before you spend too much time.

Measuring forecast accuracy can look like 1) calculating the % difference between your forecast and actuals for the CM and/or 2) taking note of how often you are adjusting your forecast outlook for the full year.

a. CM forecast accuracy

Below is an example of a metric that we populated actuals in the first row in blue as we moved throughout the year.

Below that section is each month’s forecast in each new row - the grey cells represent the fact that we already had actuals for that period so they simply equaled the actuals from above.

The bottom section is a comparison of actuals v forecast for each month.

The red highlighting is helpful in showing the months that were out of pattern (both the forecast month and the calendar month). These insights help us to know where our forecast needs fine tuning.

When evaluating CM accuracy, you get to define what an acceptable tolerance is.

I recommend looking for your biggest variance to forecast on a CM basis to determine your threshold.

Since you are just getting started with this, it’s more about picking the worst offender and improving that metric before moving to the next.

Once you’ve gone through your entire forecast and made improvements, then you should determine a threshold for what’s an acceptable forecast variance.

This will quickly allow you to know if something underlying in the business changed that caused your forecast accuracy to drop below a normal level.

b. Full year forecast accuracy

When looking at full year forecast accuracy it’s less about waiting until the end of the year to evaluate how accurate you were (that’s important too).

More importantly, it’s about creating accountability for how often and how large your forecast changes are.

I like to create a simple table (below) that shows which months we changed the YE forecast and by how much

In my book The FP&A OS (that you can find here or as a part of the FLL), I give a simple excel table that you can update every month with your forecast movements over time.

Tracking these movements ensures you don’t whipsaw the business back and forth and can easily recall the changes you made and what drove them.

3. Make it a game

When we worked in the office early in my career, we used to have a little plastic trophy from the $1 store that was given to the person with the most accurate forecast that month.

Instead of our forecast accuracy being a negative connotation, the trophy made it a game and healthy competition within the finance team.

I highly recommend doing something similar.

Most importantly it encourages the sharing of best practices across finance as everybody tends to approach forecast improvements in different ways.

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