How to de-bias revenue forecasts
Image by Miguel A. Amutio via Unsplash
Do you want to add more value to revenue forecasting as a Finance leader?
Then you should de-bias growth assumptions.
Here is how:
Like most finance teams, I assume you receive inputs for your revenue forecast from the sales, marketing, product, or growth team. Then, you take those inputs and build your revenue forecast around them.
But you can do more than apply revenue recognition rules to the inputs.
See, most projections aren’t true “50/50” forecasts, meaning they don’t have an equal probability of being too high or too low. In other words, they are biased.
Measure the bias
Look at 6-12 past periods and measure the error of previous forecasts. How much (as a percentage) did actual results differ from the latest projections? Note the share of variances that are positive compared to negative. If they are mostly equal, you don’t have a lot of bias in your numbers. But chances are they are heavily skewed to being overly optimistic or pessimistic.
Investigate
Once you know what kind of bias you are dealing with, it all comes down to asking your business partners the right questions. A lot of questions. Keep in mind that you don’t want to come across like you think you know how to do a better job than they do.
➣ Ask how they came up with the forecast. Look for step-by-step instructions.
➣ What were the data sources?
➣ What were the assumptions? What were they based on?
➣ How did assumptions include the results of the previous forecast?
➣ To what extent does it rely on historical data versus what they know about the future?
➣ And critically: Are there any concerns about being too optimistic or pessimistic? Do your business partners want to make sure they can consistently “beat the forecast”? Or do they assume a “low” forecast will make them look too pessimistic about the company’s future?
Collaborate to address your findings
Share your insights with your cross-functional business partner. Ideally, do it in a 1-to-1 meeting so you don’t put them on the spot in front of colleagues.
Clarifying the purpose of financial predictions is most important, so they get behind making changes in the first place. Stress that a forecast is not the same as a target. The purpose of a forecast is to predict financial performance as accurately as possible.
It helps to explain how the forecast is used to make resource allocation decisions and inform investors. That way, people understand why accuracy matters.
Finally, make sure they know that no one will be “punished” in any way for missing the forecast - that’s bound to happen when we have a true 50/50 forecast.
To summarize:
➣ Determine if forecasts are consistently optimistic or pessimistic
➣ Understand what may have caused the bias by investigating methods and intentions
➣ Encourage change by sharing your findings, clarifying the role of the forecast, and establishing psychological safety.
If you’d like to learn more about FP&A, I offer help in three ways:
1️⃣ Subscribe to my free newsletter “FP&A Tuesday” here.
2️⃣ Listen to 75 bite-sized mini lessons and get FP&A advice on the go.
3️⃣ Join my live online course FP&A Bootcamp to master FP&A in two weeks.
