A rolling 12-month forecast projects financial performance over a 12-month time horizon using the “add/drop” approach to forecasting. Unlike a budget or calendar year forecast, a rolling 12-month forecast adds one month to the forecast period each time a month is closed so that you are continuously forecasting for 12 months. This enables continuous planning of future performance based on actual performance. A rolling forecast model is a dynamic and advantageous way to plan in an ever-changing business environment.
Calendar year financial forecasts, the most popular alternative to 12-month rolling forecasts, are easier to build and update, but have diminishing value as the year progresses. As a result, many businesses become frustrated with forecasting in general and feel it is a waste of time.
Advantages of a rolling forecast
The 12-month (or sometimes 24-month) rolling forecast is the most important financial planning tool for your business. The insight gained from routine forecasting completely changes the way you manage your business. Would your business benefit from continuous and dynamic operating forecast? Here’s the advantages of a rolling forecast model.
Good rolling forecasts can be easily updated with the most recent financial and sales data, creating instant insight into business trends. This takes the burden of analysis out of routine planning.
Responsive and Dynamic
By accommodating new data easily, a rolling forecast is more dynamic and responsive to changing conditions. For example, during the unexpected Covid-19 pandemic, small businesses had to abandon their budgets and rely on operating forecasts to understand and plan for the new environment. This is significantly faster and easier than re-budgeting mid-year.
Like any good forecast, a rolling forecast can be used to perform long term what-if scenario analysis. This allows management to test the outcome of strategic decisions such as hiring new employees, purchasing equipment, or selling a big contract.
How to create a rolling forecast
Forecasting is half-art-half-science. An effective and efficient forecast is a combination of accurate formulas and good user experience (UX.) here are six steps to creating a rolling forecast:
- Start with revenue. Sales forecasting is the foundation – and most difficult part – of any forecast. One basic approach is using trailing 12-month trends to project forward, but that’s not best practice. Instead, we recommend performing an analysis of your sales and marketing funnel with a model to match. Check out our whole separate article on how to forecast revenue.
- Build a headcount plan. Create a list of all your employees, their department, and their wages. Then add placeholders for future hires – a lot can happen in 12-months, so think outside the box.
- Peg costs and working capital to revenue. Your variable costs, inventory levels, accounts receivable, accounts payable, and many other balance sheet items will likely change as revenue fluctuates. By using formulas to tie these accounts to revenue, they will be responsive to changing business conditions.
- Create all three financial statements. A true forecast includes a balance sheet and statement of cash flows, not just an income statement. Excluding one or two of these financial reports will cause your cash projections to be wrong!
- Tie in historical financials. Your forecast needs to tie in actual results. The easiest way to do this is add two new tabs in Excel – one for your income statement, one for your balance sheet. Best practice is to use a combination of labels, groupings, and sumif formulas to automatically update the forecast once you “drop” an updated set of financials.
- Test for reasonableness. Good FP&A analysts will test the mechanics of a forecast by adjusting variables and trying to break the model. This analysis ensures your rolling 12-mointh forecast should respond appropriately to all these changes. Examples of tests include:
- What happens if we increase sales 1000%?
- What is the impact of adding 10 new employees?
- Can we model the effect of a global pandemic changing the economy overnight?
- Clean up the model. Take one final hour to remove unused data, clean up fonts, colors, and titles, and create a set of instructions so you remember how to use the model.
Forecast Reliability and UX
Your rolling forecast should empower strategic planning and tactical decision making, not limit them because the model is too cumbersome to update. Rolling forecasts require continual updates – monthly or quarterly, at minimum. When a financial forecast is not designed to accommodate such updates easily, the monthly process becomes burdensome, errors slip through unnoticed, managers get frustrated, and companies often give up on the forecasting process. To avoid errors and bad decisions, it is vital to design a reliable update process into your model. Follow these best practices to ensure a good user experience and avoid update errors:
- Define which variable financial data will be updated and how often.
- This should be based on sensitivity analysis of key drivers
- Update key business drivers monthly, at minimum.
- Update less critical assumptions quarterly, annually, or ad-hoc.
- Highlight model variables in a special, consistent color.
- Create a checklist process for how to update the model.
- Perform period-over-period forecast variance analysis to measure changes and identify abnormalities.
Disadvantages of a rolling forecast
There are drawbacks to using rolling forecasts instead of planning tools like rolling budgets (see below) or calendar forecasts.
Difficult to Build
Creating a rolling forecast is significantly more challenging than creating budgets or calendar forecasts. An experienced analyst at CFOshare spends 30+ hours creating a rolling forecast and customizing it to your business. If you are not a financial expert, it may take you twice or three times as long. Worse yet – you likely will not design the update process efficiently, resulting in lost hours every month in the intense and complex update process.
No Good Forecasting Templates
Although there are decent templates and software solutions for other financial planning tools like budgets or cash flow forecasts, there are no good templates for rolling forecasts. That’s because rolling forecasts must be heavily customized to match your data sources and business model.
Good Accounting Required
Rolling forecasts use accounting reports as part of their inputs. As a result, if you use cash basis accounting or follow other sub-optimal accounting practices, your forecast quality will be compromised.
If rolling forecasting sounds too advanced or too expensive for your business, consider it’s micro-business alternative: the rolling budget.
What is a rolling budget?
A rolling budget is a business planning tool updated monthly rather than traditional annual budgeting. Unlike a rolling forecast which is highly automated, a rolling budget is manually compiled by management, requiring several hours per month but creating a high level of accuracy. Rolling budgets are more agile and flexible than an annual budget/rolling forecast combination. As a result, they are most useful for:
- Freelancers and solopreneurs
- Businesses with fewer than 5 employees
- Businesses with very few fixed costs
Advantages of a rolling budget
Rolling budgets empower management to shift their cost structure to match expected revenues. The process of defining a new budget every month forces an owner to face cash shortfalls and adjust expenses to match the expected revenue. The rolling budget process forces analysis of each months’ variances, becomes a form of business performance management, and creates a high level of cost-consciousness.
Disadvantages of a rolling budget
As companies get larger, the budgeting process becomes exponentially more laborious, making monthly re-budgeting a major expense. Additionally, as businesses get larger revenues typically stabilize (relative to costs) reducing the need for excessively-dynamic cost planning. Lastly, larger businesses achieve economies of scale by using more fixed costs and fewer variable costs (for example, by hiring salary employees rather than hourly contractors.) These fixed costs make actual results more consistent month-over-month. As a result, most businesses outgrow rolling budgets around $1M in revenue and upgrade to annual budgeting with a rolling forecast.
Does your business need a rolling forecast or rolling budget?
If your current financial planning process is not creating predictable and reliable results, you should consider bringing one of these tools into your business. Signs your small business would benefit from a rolling budget or rolling forecast include:
- Frequent surprises when you see last months’ financial results.
- Regularly worrying about how much cash the business has.
- Managing business expenses “week-to-week”.
- Losing sleep worrying about the business even though you are break-even or profitable.
Implementing rolling forecasts or rolling budgeting gives you the insight to understand the business trajectory and know what you need to do. If you want help creating a rolling forecast or improving your existing forecasting and budgeting process, schedule a free consultation so we can learn about your business and help you grow.