Rolling forecast: always looking a year ahead

In October, the board of a food manufacturer asks how the year will end. The controller can answer that fairly precisely, with only two months to go. But the question that really matters concerns next spring. A major customer has announced a new product line, energy prices for next year have just been fixed and an investment in a second packaging line is being prepared. Next year's budget is not finished yet. Just when looking ahead would pay off most, the organisation is looking least far ahead.

That is the problem a rolling forecast solves. Instead of a forecast to the end of the financial year, which gets shorter every month, you always keep the same horizon.

What is a rolling forecast?

A rolling forecast is a forecast that is continually updated by adding a new period at the end of the horizon as soon as the oldest period has passed. After each month-end close, the month just gone drops off and a new month is added. That keeps your view the same distance ahead.

Horizon and rhythm

McKinsey found that well-run companies maintain rolling forecasts of 12 to 18 months for their key financial variables, and review them monthly or quarterly (source: McKinsey, May 2009). According to BCG, many companies work with a forecast that is updated every quarter and has a horizon of five quarters (source: BCG, September 2021). A five-quarter horizon has a practical advantage: in every quarter you also see the same quarter of the following year, so seasonal patterns remain comparable.

Indicative guide by Firmfocus.

Driver-based forecasting

A rolling forecast that has to be rebuilt line by line every month becomes a burden within three months. The way out is driver-based forecasting. KPMG describes driver-based planning as a framework that predicts performance from a hierarchy of the levers that really matter. Deloitte gives volume, mix, price, productivity and staff turnover as examples of such drivers. So you do not forecast revenue as such; you forecast the number of customers, the volume per customer and the price, and revenue follows.

KPMG recommends reviewing the drivers themselves at least once a quarter, so the model stays accurate. Do not pick too many. For most businesses a handful of well-chosen drivers is enough to track revenue and costs.

Setting up a rolling forecast in five steps

1. 01

   Choose horizon, rhythm and level of detail

   For example five quarters, updated every quarter, at the level of product groups and main cost categories. Less detail than the budget.

2. 02

   Define the drivers and where they come from

   Which five to ten quantities determine revenue and costs? Who supplies the expected values each month: sales, purchasing, operations planning, HR?

3. 03

   Build the model

   Drivers go in, profit and cash flow come out. A clear spreadsheet is enough for most SMEs; larger organisations use planning software linked to the accounting system.

4. 04

   Update after every close

   Load the actuals, drop the period just gone, add a new one and change only the drivers that have moved. With a good model that takes hours, not weeks.

5. 05

   Discuss what has shifted

   The number itself is not the interesting part; what changed compared with the previous forecast and the budget is. Include that in the management report and agree what you will do about it.

Example: a food manufacturer with 140 staff

The manufacturer from the introduction works with a five-quarter forecast, updated every quarter. In October the update looks like this.

Fictitious Firmfocus example.

Compared with the previous forecast, two drivers have changed. Volume in the second and third quarters has gone up because of the major customer's new product line, and energy costs per tonne have come down thanks to the new contract. That leads to the discussion that matters: at the higher volume, the existing packaging line will be running at full capacity in the summer. The investment in the second line therefore has to be ready before the second quarter, not the third. Without a rolling forecast, that would only have come to light in the budget round in December.

Keep forecast and target apart

A forecast only works if it is honest. Use it to hold people to account and expectations will rise just before the review and fall as soon as there is budget to share out. BCG therefore recommends treating target setting, forecasting and resource allocation as separate processes. The Beyond Budgeting Roundtable makes it a principle: forecasting should be a lean and unbiased process, not a political exercise. EY warns against linking budgets or forecasts to bonuses for the same reason.

• The target: what you want to achieve, set out in the annual plan and the budget.
• The forecast: what will happen if you do nothing extra, based on the best information available.
• The gap: the management team's assignment. That gap is not the fault of whoever made the forecast.

How accurate does it need to be? In a PwC survey of large companies, 55% had seen actual results deviate from the forecast by more than 5% over the previous three years (source: PwC, May 2011). Perfection is not the yardstick, then. What matters more is that the forecast shows the direction in time. As McKinsey recommends, also agree a few trigger points at which you switch to a different scenario, such as the loss of a major customer or a steep rise in the price of a raw material. See also scenario planning.

Does a rolling forecast work for SMEs?

Yes, in a light form. A spreadsheet that looks twelve months ahead, five to eight drivers and an update of an hour or two a month give a business owner more visibility than a budget that is already out of date by March. Businesses with seasonal patterns, large projects or volatile purchase prices benefit most. Start simple: revenue, gross margin, staff costs and the cash balance. Once that works, expand.

In the Business Planner you keep your plan's revenue forecast, costs and cash flow up to date, so after a change you quickly have a current version for your bank, accountant or business partner.

SMEs and large organisations

If you want to go further and replace the annual budget, see Beyond Budgeting.

How the forecast connects with the annual plan, the budget and the monthly report is set out in the overview of planning and control.