We love movies and books that are based on reality. No matter how fantastic or unbelievable the events in the tale may be, it instantly has credibility if it begins with "this story is based on a true story." We are immediately drawn in. Real truth, even if sensationalized or dramatized a bit, is so irresistable.
In contrast, I give you the financial forecast. For those of you not involved in these types of things, financial forecasts are models that people build, usually in Microsoft Excel, that show projected revenue, profit, costs, and the like in an effort to track the progress of a business, to make decisions regarding strategy or tactics, and to communicate to others about the business (whether they be management, shareholders, partners, etc).
The thing about a financial forecast is that the future is unknown. A fact that we sometimes like to ignore. We can not predict the future. And as they say in Princess Bride, "Anyone that tells you different, Princess, is selling something."
So, because the future is unknown, you need to make assumptions. More like "make up" assumptions would be more accurate, as all forecasts are works of fiction. Those assumptions about customer acceptance, revenue growth, cost reductions, or the like have a huge impact on your perception of the business opportunity. They can have a huge impact on the short-term decisions that might be made. Assume a healthy economy and low product return rates and you can convince yourself to spend more in marketing, only to find out later that these assumptions were horribly wrong and the money was wasted. Assume that 20% of your products will be sold with a unique feature and if it turns out being 50%, you could find yourself with product shortages and unhappy customers. You could be off by a little or a lot. Assumptions are a killer indeed.
The best assumptions are ones that have a high probability of occurance. That high probability based on some past perforamance. If you always have a slow first quarter of the year, it safe to assume that next year will be no different. If you have a trend line extending back into time that says that revenue is growing, you have a reason to believe it will continue. Distrust step functions. There has to be reasons to believe.
It is just like the movies and books. We are drawn into the story if we believe it is based on truth. Same with financial forecasts. This is true in business, but also in non-profit organizations, churches, and even personal finance.
So, how do you create good assumptions:
1. As I have said before, trends trump step functions. In other words slow and steady trend lines are more probable than things that immediately get better overnight, like someone flipped a switch. If you are assuming a step function improvement, you better know exactly what switch is getting flipped and be confident in the outcome.
2. Understand and measure the key levers of the business for real-time feedback. If your business is dependent upon selling service contracts along with product sales, you should know what your attach rate should be and what it has been. You should be able to see the actual attach rate trends as frequently as is reasonable and should share them with the teams involved. You should know where your costs are and the boundary boxes in which things should stay for the business to be profitable. As the good folks at GE taught us, "what you measure, you improve."
3. Everyone is in the business. This means giving your employers and partners visibility to the key metrics of your business will make you more successful, as choices are made at every level of the organization that greatly impact the success of the business and the factors you are measuring. Now, I am not talking about disclosing financial information inappropriately or giving away company secrets. I mean teaching all the players in the game how the score is kept, how to read the scoreboard, and their role in putting points on the score board. Remain open for anyone on the team to suggest a better play to call to reach the goal, once they understand the rules of the game. These kinds of conversations are the basis of true teamwork.
In contrast, I give you the financial forecast. For those of you not involved in these types of things, financial forecasts are models that people build, usually in Microsoft Excel, that show projected revenue, profit, costs, and the like in an effort to track the progress of a business, to make decisions regarding strategy or tactics, and to communicate to others about the business (whether they be management, shareholders, partners, etc).
The thing about a financial forecast is that the future is unknown. A fact that we sometimes like to ignore. We can not predict the future. And as they say in Princess Bride, "Anyone that tells you different, Princess, is selling something."
So, because the future is unknown, you need to make assumptions. More like "make up" assumptions would be more accurate, as all forecasts are works of fiction. Those assumptions about customer acceptance, revenue growth, cost reductions, or the like have a huge impact on your perception of the business opportunity. They can have a huge impact on the short-term decisions that might be made. Assume a healthy economy and low product return rates and you can convince yourself to spend more in marketing, only to find out later that these assumptions were horribly wrong and the money was wasted. Assume that 20% of your products will be sold with a unique feature and if it turns out being 50%, you could find yourself with product shortages and unhappy customers. You could be off by a little or a lot. Assumptions are a killer indeed.
The best assumptions are ones that have a high probability of occurance. That high probability based on some past perforamance. If you always have a slow first quarter of the year, it safe to assume that next year will be no different. If you have a trend line extending back into time that says that revenue is growing, you have a reason to believe it will continue. Distrust step functions. There has to be reasons to believe.
It is just like the movies and books. We are drawn into the story if we believe it is based on truth. Same with financial forecasts. This is true in business, but also in non-profit organizations, churches, and even personal finance.
So, how do you create good assumptions:
1. As I have said before, trends trump step functions. In other words slow and steady trend lines are more probable than things that immediately get better overnight, like someone flipped a switch. If you are assuming a step function improvement, you better know exactly what switch is getting flipped and be confident in the outcome.
2. Understand and measure the key levers of the business for real-time feedback. If your business is dependent upon selling service contracts along with product sales, you should know what your attach rate should be and what it has been. You should be able to see the actual attach rate trends as frequently as is reasonable and should share them with the teams involved. You should know where your costs are and the boundary boxes in which things should stay for the business to be profitable. As the good folks at GE taught us, "what you measure, you improve."
3. Everyone is in the business. This means giving your employers and partners visibility to the key metrics of your business will make you more successful, as choices are made at every level of the organization that greatly impact the success of the business and the factors you are measuring. Now, I am not talking about disclosing financial information inappropriately or giving away company secrets. I mean teaching all the players in the game how the score is kept, how to read the scoreboard, and their role in putting points on the score board. Remain open for anyone on the team to suggest a better play to call to reach the goal, once they understand the rules of the game. These kinds of conversations are the basis of true teamwork.
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