Deep dive into Business Forecasting
And increase your business value.
by Chia-Li Chien | Apr. 10, 2014
In my previous article, How well do you forecast in business?, we explored the difference between forecasting and budgeting and how a business forecast can allow the planning required for business success.
Remember, the key is to be more proactive, rather than reactive, in achieving business goals.
But when you look at a business forecast, what do you look for? In The Design of Business by Roger Martin, he summarizes three things owners of public or private enterprises must look for:
1. Reliability – Known as R2, this is one of the key measures for how accurate, reliable and positive correlation the forecast is. This involves in-depth research from within your company’s historical data pattern, seasonality, as well as industry and economic trends.
2. Validity – Is the platform or business model even valid after looking at the forecast?
3. Advanced Knowledge – What do you gain based on the forecast? Can you apply this knowledge into your product design or address market needs with favorable methods?
Janet had a new product idea for which she prepared a very complex 10-year forecasting system. It included sales trends, profits, ROI (return on investment) and payback period for the investors. It also targeted specific types of investors and ways to approach them for the initial capital needed for this product launch. Janet’s business is in the top 3 in her industry and has been growing steadily. This new product will help diversify her entire product portfolio and further reduce the risk of product concentration from 90% to 40% within the first 5 years of launch.
When Janet asked me to take this forecast and create a pitch plan from it, I realized that all three major key points above were missing. The data from the forecast was not traceable, meaning the data was basically made up; therefore the reliability of the forecast was not even there to begin with. The business model for the product was missing large parts of resources capacity, specifically in people and technology. In addition and most importantly, the business model and platform was not valid. Lastly, no advanced knowledge was produced, despite a fancy spreadsheet, on how to address the market needs and setting trends. As matter of fact, everything was just to catch up to the tail end of the market trend.
Remember, in any product life cycle, you can capture the most profits from buyers from phases such as the innovators (2.5% of the market), early adopters (13.5% of the market) or early majority (34% of the market) according to Start with Why by Simon Sinek. In Janet’s case, she simply was trying to capture a small portion of the late adopters of a product life cycle, which is cutthroat competitive and presents a thin margin. Take the iPad as an example. I was a late majority. We got our iPad4 in late 2012. Can you see how the tablets market is going? There will continue to be less expensive models or alternatives out there, until newly innovated technology comes out. Can you see how competitive the tablet / iPad market is, especially in the late adopters phase?
You become the leader and owner of your business by leveraging a solid forecast. This can help your business create tremendous equity value for you and your family. According to Boston Consulting Group, great leaders demonstrate these three characteristics:
1. Anticipate Change
2. Diversify their network
3. Are not afraid to abandon past successes and dare to make a difference
Having a great forecast can help you obtain the characteristics of a great leader.
The question is, how do you do that? Let’s take a look at the forecasting process.
Step 1: Define your forecasting goals and objectives.
Step 2: Identify the type of data and where to get the data. Data can include:
• Qualitative – social, economic, consumer, etc.
• Quantitative – financial numbers, production capacity, etc.
• Internal – historical data within your own business such as sales, marketing, financial data.
• External – Industry benchmarks and trends or economic and global data.
Step 3: Criteria to measure your forecast –indicators to meet the forecast factors such as reliability, validity and advanced knowledge.
Step 4: Call to Action – Go or no-go on the next action items or project next steps.
On November 28, 2012, Costco announced it would issue early cash dividends to shareholders to avoid the Fiscal Cliff Tax Boost, according to The Associated Press. This was to help their shareholders pay a lower tax rate on their dividends— 10% or 15% instead of 15%, 25% or ordinary income tax rate. Obviously, a huge difference for investors but only Costco could control the timing of issuing the cash dividends. So the goal was to help shareholders avoid paying the higher tax rate on dividends. Who wouldn’t want that?
Let’s walk through how Costco prepared the forecast:
Step 1: Goal – To validate the cash flow capacity and impact of overall financial health of 2-month earlier cash dividend issuing by mid-Dec 2012.
Step 2: Data – Historical internal financial data such as P&L, Cash Flow and Balance Sheets as well as the industry benchmark data to compare how they stack up. In addition, consumer sentiment about this tax hike, along with a policy maker’s general tax increase directions. Also, impact on Costco’s brand image and its related marketing syndicated data.
Step 3: Indicators to measure reliability, validity and advance knowledge – What’s the acceptable range of the R2 and how valid is the forecast? Can this forecast predict how the consumer will react during the holiday season and beyond?
Step 4: Go or No-Go for issuing an early cash dividend along with next implementation steps.
As a proud Costco member and shareholder, I can tell you that Costco did pay just over $3 billion in a special early dividend or $7 per share in December. 2012, instead of January. 2013. It boosted the overall Costco brand image, not to mention member loyalty, and best of all, they received free publicity that further boosted both stock price and Costco’s bottom line! What a brilliant and carefully calculated marketing campaign!
At this point, you may be wondering why your own financial team has not shared this information with you. As an adjunct faculty member, I’ve been teaching a forecasting class for the American Management Association (AMA) for years. It is not something you simply know intuitively. The good news is you can learn about the techniques in the public classes offered by AMA or engage my team and I to customize your forecast process. This will reposition your business well to capture the business value you deserve!
I am available to my newsletters subscribers for a free one-on-one forecasting consultation. Just drop me an email email@example.com and let’s get started!
About Chia-Li Chien
Chia-Li Chien, CFP®, CRPC, PMP; Chia-Li “like JOLLY,” Succession Strategist of Value Growth Institute, dedicated to helping private business owners increase their company equity value. She is the award-winning author of the books Show Me The Money and Work toward Reward and a faculty of the American Management Association. Her blog and newsletter was named a Top Small Business Resource by the New York Times You’re the Boss blog. Contact her at firstname.lastname@example.org or (704) 268-9378 .