Forecasting for Success: A Process, Not an Event

3/4/2015 - By Zachary Farrington

This excerpt is from our Winter 2015 Dimensions Newsletter

The construction industry is notorious for its boom and bust cycles. If you don’t want to be constantly reacting to these cycles — scrambling to keep up with the work one year, then downsizing the next when things slow down — it’s important to plan your company’s growth, rather than merely respond to opportunities as they arise.

The first step in this planning process is forecasting. A realistic and credible forecast provides the foundation for all the budgeting and planning steps that follow.

Bear in mind, however, that forecasting is more than a one-time event. Rather, it’s an ongoing process that requires regular readjustment and revision. In fact, the forecasting process itself adds value by causing you to challenge your assumptions and analyze the workings of your business to determine what you think is possible, how you’re going to achieve it, and what resources you will need to meet your goals.

The Purpose of the Forecast

The first question you must ask when you begin working on a forecast is “Why?” Why are you forecasting? Are you preparing the forecast as part of your ongoing planning and budgeting process? Or do you need it for a specific purpose, such as getting a loan or preparing your company for sale? While the forecasting process itself will generally be the same regardless of the reason, the level of detail and the way information is presented may differ, depending on the purpose.

The next question to ask is “How much?” And not necessarily “How much business do we expect?” Rather, the operative question is, “How much profit do we want to produce?” By developing a bottom line target first, you can then begin the process of working backward to determine what steps you need to take to generate enough income to realize this profit.

The forecast is the first step in a recurring cycle. It is used to develop a budget, which in turn provides the basis for developing a detailed operating plan. And the operating plan will reveal areas where your original forecasts may need adjusting, either because conditions changed or because you do not have adequate resources to achieve the forecast results. So the cycle continues.

Drivers and Followers

Accurate forecasting requires a clear understanding of the driving factors in your business. One obvious driver is revenue. By analyzing historical performance, you can forecast fairly accurately how much overhead, administrative expense, gross margin and net profit will be generated for every dollar of revenue. For greater precision, analyze these figures for various types of projects in order to identify which jobs are more profitable and then adjust your forecast accordingly.

Another major driver is labor. Payroll taxes, workers’ compensation, health insurance and payroll administrative costs will follow labor costs very closely. The cost of direct materials is another key forecast driver, while office supplies and similar SG&A costs are followers. Focus on accurately forecasting the driving factors, and the rest of your forecast will follow.

Challenge Your Assumptions

Every forecast involves making assumptions. For example, you might assume your job costs will break down into four major categories: 30 percent labor, 30 percent materials, 30 percent subcontractors and 10 percent other.

Accurate forecasting requires that you challenge your assumptions by asking “How?” and “Why?” For example, are you basing your job cost assumptions on historical data? If so, will the new work you are targeting be comparable?

To cite another example: If you are targeting 20 percent revenue growth in the coming year, do market conditions suggest that such growth is possible? Equally important, do you have access to the labor, equipment, capital and other resources you will need to meet that expectation?

If you need additional equipment, do you have adequate capital or credit to acquire that equipment? If you buy it on credit, will the revenue it generates be enough — and will it be collected rapidly enough — to meet your debt service obligations? Or should you lower your revenue forecast in order avoid creating cash flow problems?

By challenging your assumptions and thinking through their consequences in this way, a forecast becomes more than just a static document. By regularly comparing actual results to your expectations, a forecast becomes a valuable and practical tool that helps you actively manage your company’s growth.