"There's only one thing you know about your forecasts," says Steve Morlidge, former controller with Unilever Foods and currently director of consulting firm Satori Partners. "They will be wrong."
Although the act of making predictions is as old as time, the forecast is a relatively modern creation. The forecast was originally developed for the maritime industry, created by Admiral Robert Fitzroy in 1860, who was best known for being Charles Darwin’s captain on HMS Beagle. His weather forecasts were designed to reduce sailing times with better wind charts, and served to replace the existing method of predicting weather - which was to monitor the excitement of a frog in a jar.
The frog in the jar, while cheap, was not particularly effective. Between 1855 and 1860, >7,000 ships were wrecked off the British coast due to the frogs failing to jump around enthusiastically enough before a storm. Fitzroys innovation was to use the telegram system to track storms as they developed, and warn a port before they arrived. Like so many innovators, he was mocked, ignored, and eventually admired.
Since then, the forecast has evolved, not only focusing on weather, but all aspects of our life. Financial forecasting has, in itself, become both an art and a science. Many large businesses, such as Amazon, have made their ability to forecast a competitive advantage - wielding AI and massive amounts of data to plan sales, inventory and headcount in almost real time. But on the other end of the spectrum, many businesses are still reliant on the modern day frog in the jar - a spreadsheet full of assumptions and gut feel.
The spreadsheet in itself is not a bad tool, and its flexibility has given it the ability to solve problems for almost 1 billion people. But just as the frog was never designed to predict the weather, a spreadsheet was not designed to observe the changes in the world in real time. For many, the act of forecasting becomes an act of pageantry performed on an irregular basis. The goal may be to secure investment or make a budget, but ultimately, these forecasts are accurate “0.00% of the time one year after issuance” according to Phil Nadel, co-founder of Forefront ventures.
Well, for businesses, the first thing is that while you can make many bad decisions in your business - you can only run out of cash once. It cannot be overemphasized how important cash management is for any company, big or small. You can miss sales projections, you can underperform on quarterly earnings - but you must never, ever, run out of cash. And yet 80% of the small businesses that ran out of cash had no warning it was going to happen - with business owners saying that the knockout blow for their company came as a complete surprise to them. In many cases, they did make forecasts, and of course - these projections were wrong. But that is not what killed them.
Should I take an umbrella out in 3 months time?
When Phil Nadel says that “0.00% of financial forecasts are accurate 1 year after issuance”, it would be easy to overlook the crucial part of this quote, which is that the time frame is 1 year. And the reality is, it is simply impossible to predict what the world looks like in a year - but that doesn’t matter, because you don’t need to predict what next year happens. Instead, the challenge is to continually update your predictions over the year.
Rather than try to estimate every single day you may need an umbrella for the next year, it is more accurate to look on a day to day basis. And this learning from our personal life is something businesses can learn from.
The secret to forecasting is not to spend weeks accurately predicting a distant future, it is to refine and automate the process to such an extent that your forecasts can update in real time. For some, this is to move from a quarterly planning and forecasting cycle to a weekly cycle, but for Amazon they have refined the process to such a great extent that the forecasts are updated on an almost real time basis.
This may seem like overkill for a small business, but ask yourself this. If 80% of businesses fail to forecast that they are going to run out of cash - how different is this to the sailor whose frog didn’t warn him of a storm?
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We are repeating the mistakes of the British Navy. Relying on a flawed way to forecast our business’ financials. Here’s what we should do instead.