How to Produce an Accurate Forecast
Forecasting for Success
Forecasting is one of the most challenging activities for finance and project teams. The project teams often do not realize the impact they have on the company’s overall forecast and the effect on the organization’s overall strategy. It is the grass roots project plans for awarded work as well as forecasted opportunities that guide the business. The building blocks of the Annual Operating Plan (AOP) and Long-Range Plan (LRP) are the project forecasts; there is not a magic forecast that comes from the corporate finance team. These plans (AOP and LRP) are critical for all decision-making, and engineering companies that do a great job forecasting will be more efficient and successful.
Why is forecasting so hard to do? There are so many moving parts, making it hard to get arms around all the components of a forecast at one time.
Communication and collaboration is the most challenging aspect of forecasting. The number of touches above explains why it can be challenging to produce an accurate project forecast! In this paper, we will discuss methods, techniques, and tools that will help you engineer an accurate forecast.
Annual Operating Plan (AOP) is a short-term, highly detailed plan used to achieve tactical objectives.
Long Range Plan (LRP) is a set of financial goals (usually five to ten) that outline the path for the company's future.
What is the Difference Between Budgeting and Forecasting?
Forecasting is the activity of predicting what will happen in the future. A forecast can be compartmentalized as short, medium and long term. It is based on the best assumptions known at the time of development of the forecast. These assumptions will change over time and the forecast will need to be updated to reflect the changes.
Budgeting is what the organization believes is achievable. There should be an action plan in place to achieve the budget. The budget is a target which the organization sets for itself, and the budget becomes management's commitment to action.
The tips and methods below are applicable to both budgets and forecasts. Budgeting is a vital part of the process giving the business a starting point that will indicate performance over time.
Time Phase Your Budget and Forecast
Unfortunately, businesses still try to budget and forecast using lump sums by year with minimal break out of labor, material, and ODC. Lump sum methods provide no actionable information for the business.
The best practice would have the forecast broken out at a minimum by month but could be done by week. The units (month or week) needed are driven by the nature of the business. For instance, if you have short duration projects (6 weeks) with specialty labor you would want to budget and forecast by week instead of by month, otherwise there will be no time to course correct if issues arise. With the specialty labor needed, it will be necessary to make sure the talent is available at the time the project needs the skills. Time phasing will also allow you to look at date ranges such as month, quarter, 1st and 2nd half of the year, and your fiscal year if different than a calendar year enabling comparisons and analytics.
Near-term and mid-term plans should be broken down into weeks or months. These forecasts can be used to form the basis for the out years adding credibility and past learning so that the future can be more accurate. Make sure you have a system that allows you to time phase and group in date ranges.
Start with the Pipeline
Let’s start off with the definition of an opportunity pipeline. For a project-based business it is the visualization and/or measurement of contracts or projects that you will attempt to win over time. The time horizon can be “time now” to 5+ years into the future depending on the planning needs of your business or the length of your sales cycle. An opportunity pipeline is the incubator for your business growth and it should reflect your company’s overall business strategy. The most compelling reason to have an opportunity pipeline is to understand the revenue forecast and resource needs for the future. The revenue forecasts will be the barometer of your company’s future financial health and will be an element of the AOP and LRP forecasts. Managing the pipe will help you adjust forecasts as opportunities move through the business development gate process. It will also paint the picture of the future with all variables included.
Establish a Resource Management Practice
“People are our most important asset!”
If people really are the most important asset a company has, you would think they would work very hard to manage and invest in their people, yet so many companies struggle to truly manage this resource. Many times, resource planning is done too late in the process to make a difference and the result is behind schedule and over cost projects. Even if proposal and project managers want to plan their resources, the reality is that most resource planning is done ad-hoc with Excel files at the project level. There is no consideration of skills or what other projects need and there is no clue what new work will require from a resource perspective.
It does not have to be that way!
Below are 8 simple tips to help increase the efficiency of managing resources across the enterprise:
- Have a centralized repository for all resource plans that is accessible to all stakeholders
- Create a skills catalog so that the right resources will be available when (and where) you need them
- Forecast resources throughout the project lifecycle, don’t just start at contract award
- Use a pool of resources across your company not just on one project or portfolio
- Include named resources where specific employees are key to the success of the effort, or unnamed TBD resources to align to specific skills or new hire requirements
- Plan at the project level and roll-up to the enterprise – do not forecast by department only
- Provide stakeholders real-time resource demand and KPI reports as well as role-based dashboards
- Don’t plan your most important resources on disparate excel spreadsheets
Model Scenarios for Best Fit
Modeling scenarios, sometimes known as what-iffing, is a great way to assure you are picking the right path and maximizing resources. For example, you can ask: What if rates change (up or down)? What if we outsource, instead—will that save us money or provide additional opportunity to use in-house resources more effectively (trade-offs)? If not for a specific project, will that shift free up resources within the portfolio of the company and save money elsewhere?
When forecasting the long-range plan, factoring will be necessary to account for uncertainty. One method to use for factoring is using the probability of award (POA). The POA utilizes two criteria, probability of win and go. The probability of win multiplied by the probability of go provides the POA.
Having a system that will allow for what-iffing and factoring will play a huge role in the accuracy of the forecasts and will help to formulate budgets.
POA can be a great tool for portfolio-level analysis, at lower levels in the analysis, you will want to recognize that the effort will either be won at some expected value, or lost. The expected value will be more precise and should be utilized for near-term work where you are more certain of the award.
Utilize Rate Calculations
There are multiple types of rates - Labor, overhead, G&A, and fringe. Some types of projects may have different types and rates for labor, where the client is purchasing labor and specific types of labor at a defined rate. It is critical to have the ability to look both at the actual rates being charged as well as bid rates to determine profit by resource. Often proposed rates will be different than actual rates, budget rates different than forecast rates, forecast rates are different year over year, and having the ability to apply multiple rate scenarios to your direct cost is very valuable.
Rates play a big role in revenue forecasting assumptions. For instance, if your overhead rates are less than you predicted on cost plus projects, the actual revenue recognized will be less. On fixed price projects, higher than anticipated rates will eat into planned profit. Having revenue forecasts for the 1-5 year horizon will help the finance team more accurately predict corporate or forward pricing rates. Managing rate forecasts are important for all contract types and communication of rate changes to project and proposal teams will help eliminate a rate impact surprise. Teams should also discuss the ability to predict changes in an out-year rate, based on the expected potential new awards that will impact corporate rates.
Top Down Planning vs Bottom Up Planning
In the process of top down planning, the objectives and path to achieve goals are driven from the top. First, top goals are set, and ways to achieve them are established. These steps to achievement are gradually moved to lower and lower levels of the organizational hierarchy to be developed and specified.
Below are the pros and cons of top down planning:
- C Suite typically develops the plan and already buys-in
- Quicker way to forecast – short cycle time
- Aligns with corporate strategy
- C Suite might not understand the issues/risks at the project level
- Little to no buy-in from the project managers
- Must back into the resource plan for the top down mandates
Bottom up or grass roots planning is a technique based on the concept of asking those who are close to the project, client, and subcontractors (such as project managers, department managers, etc.), about what they need from a resource perspective, what they think the risks and opportunities are, and account for any constraints, (ex. skill sets or technical) and then roll that up to higher levels in the organization.
Below are the pros and cons of bottoms up planning:
- Project teams actively work to establish a cost and schedule forecast
- Improved communication at the project level and buy-in for the plan
- Potentially more accurate at the project level
- Cycle time to complete planning will be longer due to the detailed nature of the planning
- The scope of the contract or project must be crystal clear
- May not tie to the overall corporate goals
- Alternatives may not be explored to meet the corporate goals
Top down and bottom up forecasting both have a place in your process and business environment. The type of projects will dictate when and where to utilize each methodology.
Find the Right Level to Forecast
Budgets and forecasts are used in many ways throughout the business and multiple methods will be needed as we discussed above. This next point is obvious, but near-term forecasts are more accurate than long-term forecasts since there is more visibility into the scope, schedule, current economic conditions, resource availability etc. Looking in the future is more difficult and the level of granularity of the forecast will be less detailed since many long-term projects are still in the proposal phase or in the “crystal ball” phase with many unknowns.
Grouping projects makes it easier to forecast especially in the mid-range time (3-5 years). Those groupings may be by programs, client, product, business unit, portfolios, or department. You can look at these forecasts in aggregate and derive an accurate forecast because you understand the client demand, your capacity, and potential growth. Forecasting using constraints and other pertinent information can make for a very good forecast. Using very detailed forecasts in the long-term will take lots of time and will not be accurate. Save the detailed forecasting for 0-2 year (unless you have a high level of confidence in the client and market). There is also a check of reasonableness that needs to be added. C Suite members and project teams need to work together to decide on the level of forecasting needed and for what purpose it will be utilized. For example, an AOP is a short-term forecast and granularity is necessary. An LRP may need to utilize detailed forecasting for an agreed-upon time period and then utilize a grouping for out-years. One other thing to think about is the frequency of the update and who is needed to provide input.
Communicate and Collaborate
Projects in and of themselves are social. There must be constant and continuous interaction between the departments, project personnel, executive management, subcontractors, and most importantly, the client. If projects themselves are social, the overall business must recognize social needs. The business needs to provide all the stakeholders a way to communicate and facilitate a culture of collaboration. Successful projects are the lifeblood of a project-based business.
Establish a business cadence that encourages or forces collaboration. This is a calendar of events and interactions that will happen on a daily, weekly, monthly, quarterly, bi-yearly, or yearly basis. A great example of this is a weekly meeting with the resource manager and the project manager to establish needs.
Having a system that everyone can access is also critical. Invest in tools to better your business and get out of the siloed spreadsheets and disparate tool sets (beware, some tools are disparate even though they have the same name placard on them).
Your business deserves one source of truth that only Unanet can provide. The benefits of the Unanet tool are unsurpassed by any other project-based ERP tool. The advantages of using Unanet are:
- Streamline project reporting by offering managers insight into true margin
- Provide capability for planners and project managers to budget using indirect rates
- Expedite real-time information and decision-making
- Forecast direct charges, indirect charges, and revenues
- Integrate budgeting and forecasting data with workforce assignment and actuals for labor and expenses
- Achieve effective resource utilization and improved service levels with lower overhead
- Understand capacity, revenue, cost, and work schedules
- Identify any load level overbooked resources
Unanet will support the way you work:
- Create opportunities and projects with flexible business rules
- Constrain budgets/dates at the project, task, and person level
- Plan periodically, using a calendar or your own fiscal definitions
Unanet provides powerful project budgeting and costing:
- Provide rate flexibility and date effective values - person, labor category, or any project or task level rate override
- Powerful reporting capabilities including graphical dashboards and summary, detailed, and periodic reporting using custom accounting calendars
- Calculate fully burdened project costs with a suite of reports showing direct and indirect costs associated with a project, using target, provisional, or actual rates
- Report by client, project, or task level
Plan future work:
- Plan people or people types for projects based upon availability and skills
- Plan or assign people for multiple periods for a project, or multiple projects, in a powerful grid format
- Show direct costs, indirect charges (e.g. Fringe, Overhead, G&A, etc.), hours, average labor rate, revenue, and margin on a single report
- See detailed direct charges by labor and ODC cost element