Forecasting Versus Predicting and Budgeting

When doing strategic planning it is vital to “run the numbers.” We run the numbers in all our tax structuring models. This process allows us to pressure test assumptions and make sure the path we are considering is viable. This process also provides decision makers with information that trains their intuition, helping them make better decisions.

There are budgets, forecasts and predictions and often I find that many professionals and executives do not clearly understand the differences between them. Accountants often times view budgets as forecasts. Sales and marketing people often view forecasts as predictions. They are each very different and serve very particular objectives.

Budgets, for example, are to manage costs and hold department heads to spending guidelines. Predictions are statements of certainty about the future, and are based on a belief that no matter what happens between now and the future, the outcome will not change. Predictions are highly speculative, rigid, and rely on intuition and feelings. They share with forecasting the use of historic experience in their conception, but that is where the similarity ends. In my early career in forecasting and financial modeling we had a saying, “There are two kinds of predictions, bad ones and lucky ones.”

Forecasts, on the other hand, are logical models that show the range of possible outcomes based on the interconnection between various factors. Forecasts can help us see into the possible outcomes in the future by modeling the way certain influences can combined to change demand, supply, trends, and customer needs.

Predictions only happen in a world where the future is pre-assigned. They are precise statements about the future. Forecasting acknowledges that hidden currents can act in concert to create a range of possible outcomes. Forecasting is also the result of continuous refinement. It is constantly modifying the model based on refined understanding of hidden currents and their interactions

Unlike budgeting, forecasting is not linear. Forecasts are about turning points and if you graphed the range of outcomes the line would be more “S” shaped. Budgets are linear because they are based on a cost per unit or person. Budgets are not factoring in uncertainty. Forecasts are all about uncertainty. A good forecast is looking at possible disruptors that will turn the line into an upward growth cycle or downward spiral. This is the beauty of forecasting; it develops an understanding of how hidden currents in your business environment will impact your business. As the model becomes more refined and the range of view shortens, the range of uncertainty will generally narrow, but it will never go to a singular point. That would be a prediction.

Effective forecasting requires following the following four guidelines

1. Accept uncertainty: As Poor Richard would say “nothing is certain but death and taxes.” Understand what is uncertain and factor that into your forecast. A good forecaster knows the difference between a highly uncertain possibility and a wildly impossible one.

2. Learn from the past: The past can help the forecaster understand how environmental currents interact. Look the lessons of the past in building the model.

3. Find the disrupters: The future is not a linear extension of the past. There will be new events and factors, different choices and unintended consequences that can profoundly create and change trends. A good forecaster is looking and listening for those.

4. Do not fall in love with your predictions: Once a forecaster becomes a predictor the forecast becomes a rationalization of the prediction and certain hidden currents or factors in the model take on too much emphasis.

5. Refine and adjust: A forecast is an ongoing, iterative process. Keep learning and refining.

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