The Lean Business Blog

How can Forecasting be Separated from Objectives and Tasks?

Posted by Yngve Dahle on April 6, 2016

This blog post is co-written by Yngve Dahle and Mark Robinson.

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An important precondition for making a business plan is that your company’s everyday activities should be linked to its long-term strategies. Unfortunately, very few entrepreneurs do this. Strategy documents are often drawn up by senior management, only to be left languishing in a desk drawer. Each department sets its’ own objectives and tasks, while the financial manager makes the forecast. Often none of these planning activities are coordinated with each other.

This lack of coordination becomes even more problematic when you are working with a dynamic plan that may need to be changed and improved every day. If we are to work in a Lean manner, we need to be willing to challenge and attack every single decision we make. How are we going to do that if we cannot see the economic consequences of those decisions?

Building the forecast from the objectives and plans

The logical consequence of this is that we need to build our forecast on the objectives and tasks (which are linked to the business idea and model, as explained in previous blog posts). This is not a new idea. Activity Based Costing and Balanced Scorecard (Cooper and Kaplan, 1988) expanded on this concept more than 30 years ago. It is pretty logical, really. If you are a business, one of your most important objectives will always be to make money. Thus the revenues can be generated from the objectives. Also, everything that costs money in your business can be defined as a task or an activity. It is only the activities that cost money. That means that the cost part of the forecast can be generated from the tasks.

Not only does this remove the need to create a separate budget (which is one of the most dreaded tasks for many entrepreneurs), it will also allow you to update the forecast every time you add, delete or change an objective or a task. Doing this type of update is one of the main functions of working in a Lean manner, so it is something that will occur every day. Since the objectives and tasks are linked to the business idea and business model, you will actually have a through-going dynamic system. If you decide that you want to pivot from one business idea to another, you would be able to see the consequences of your actions right away.

Forecasts - are they not complex and difficult?

So – is building a forecast difficult? We do not think so. You just have to think simply and logically.

For example, imagine you run a men's hair salon in which you are the only hairdresser. Say that your hair salon is in a small town with 8,000 people. Half of the people are men, and out of these 50% are adults that go regularly to the hairdresser. That means the hair salon has 2000 potential customers. Your business model is to only cater to drop-in customers in the shopping mall where it is situated. You know that a quarter of the population of the town never visits the shopping mall. This means that the chosen business model cuts the potential customer group down to 1500 people. The shopping center also has another hair salon. This is a mixed sex salon with one hairdresser. You estimate that you can get two thirds of the men coming to the mall as customers, which translates to 1000 customers each year. If each of them cut their hair 4 times a year, you can sell 4000 haircuts each year. If each haircut costs $30 on average, your first objective would be to have $120,000 revenue a year, or $10,000 a month.

Then you start with the tasks. One task is to pay your own salary which could be $ 5,000 a month. Hiring your extra helper could cost $ 1,500 a month, and rent and other costs could be $ 1,500 a month. This will give you a potential profit of $2,000 a month if you have no other cost-generating activities.

The most important thing is that linking the costs to the activities will create the most flexible profit and loss overview. If you decide to drop an activity, it will be easy to delete the cost for that activity. If you don’t need the extra helper, the cost will be reduced by $1,500.

The cash flow forecast can be built automatically on these numbers. It provides an overview of all anticipated payments in and out of the company, plus the available cash your company has at any time. The overview shows whether you have enough money available to fulfill your obligations at each payment due date throughout the year. In addition, you will have an overview of available cash so you know how to finance planned investments.

The budgeting and investor paradox

One of the advantages of this way of thinking is that you do not have to focus on the deviation between the results you actually achieve and those you budgeted with at the start of the period. Instead, you should focus on the forecast for the whole plan period. You should combine the actual figures for the months lying behind you with the best estimate for the months ahead. The important thing is that you make your decisions based on the most accurate information you have available at any time.

Think about it. How can you be Lean when you base your reporting on measuring deviations from the budget? The budget is based on the plan you had at the start of the year. Being Lean means that you probably have a totally different plan now. You will have changed both objectives and tasks, perhaps even pivoted the business idea. How can it be helpful to measure deviations from the plan that you are no longer following?

Investors and owners often accentuate this problem. We have often met the argument –DzYeah, we know that it is ridiculous to report budget deviations, but our investors think that the original budget is a part of the agreement between us and them. They do not accept that we are changing our plan, no matter how much the environment changed.dzTo this we can only respond that there should be better and more dynamic communication between investors and entrepreneurs. A situation where the investors prevent the entrepreneurs from improving on their plans and adjusting their forecast cannot be good.

We hope that this blog post may inspire you, and perhaps start a discussion. If some of the entrepreneurship terminology used is new to you, you will find it better explained in the Overview chapter of our Lean Business Planning book. You can download a free introduction to the book by clicking the call to action below.

Topics: Objectives, Forecasting, Tasks

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