Ok, so you're in charge of building a forecast for your company and you don't know where to start and after doing some googling, you realize you'll need to differentiate between baseline/organic and incremental forecast. Maybe your should start by reading our ultimate post on sales forecasting.
Splitting the forecasting task between organic forecast and incremental forecast is a pretty common task in large companies.
A good forecast is always the combination of the organic growth and incremental volumes. Good forecasting is making the difference between the two different concepts and gets different approaches to solve them, before consolidating them into one single robust sales & financial forecast.
Organic forecast - the "Business as Usual" forecast component
When you keep doing the same things
Organic forecast is basically made of the predicted volumes if we consider that day to day operations keeps going on the same way. Let's say you have no major projects, operations runs smoothly, new customers keeps coming at the same rythm, call center keeps on operating the same way as usual, sales people keeping on closing deals at the same pace. It's also called a baseline forecast, a "business as usual" forecast or "baseline" forecast. These are synonyms for the same concept.
It's quite not hard to conceive; when your business is starting to scale, you see some mass effect and repetitive patterns coming in: customer churn rates being more or less steady, linear marketing spendings to support the activity, scheduled marketing campaigns, product realeases and so on. From this general level of activity, you can extrapolate from the past what the future will look like. It's not 100% accurate, but it's quite fair to assume, most of the time. This is pure statistical law: when numbers start to grow big, you can find regular patterns into them - like gaussian distribution among the population. This applies pretty well to businesses.
Baseline forecast with statistics
One of the best approach to forecast the "baseline" is using a statistical forecasting tool. In terms of tools to run the forecast, you would need to leverage time series analysis, statistical forecast (we can help you with that) and in general, every tool based on pure statistical law modelling. Using such a forecasting tool will allow you to reveal hidden patterns, capture trend and seasonalities existing in your dataset.
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Who can build an organic forecast? You could definitely leverage the expert of statisticians or good business analysts, while in most the cases, this Business as usual forecast is being performed by the Finance / controlling department, heavily relying on Excel formulas and a lot of business knowledge. Different hypothesis are being used and the granularity of the model will depend on the time you want to invest and of course of the level of granularity of your numbers. Baseline forecast can be made at a daily level or weekly level. The larger the company, the more granular the sales and financial baseline forecast will be.
Work top-down and bottom-up
A good approach to build an organic forecast it is to work top-down and bottom-up and then to reconcile both approach. Start by forecasting the big picture and try to break it down. Do then the opposite process and then go from a granular forecastable dimension (E.g. your customer segments or your lines of product) and sum them up until you can reconcile these granular and multiple small forecasts with the largest baseline forecast you need to achieve. Bottom-up is a good process to understand if a baseline forecast is somewhat realistic - or totally unachievable.
Leave aside macroencomics 99% of the time
So what about macroeconomics effect when it comes to forecast a baseline? Macroeconomics effect can have an impact on the baseline forecast - and will definitely have one, but their effect is way to complex to be factored in. An economic recession, a sanitary crisis at global level such as the COVD-19 outbreak, will have an impact on the performance of your activity; no doubt about it. These effects won't be modelized directly as accurate data points are most of time missing.
Incremental forecast is everything which comes on top of the business as usual forecast
Businesses never stand still
New projects are expected to be launched, changes in operting model, call center restructurations, products are being brought live to the market and country expansions are accelerating. These initiatives come "on top" of the existing business and operations, they are here to accelerate the growth of your business. If operational execution is good and assumptions being met, then this should have a direct impact on the bottom-line of the P&L. This impact of the new initiatives will need to be factored in.
Special events need also to be part of the "initiative" forecast
Events occurring every 4 years such as a soccer world cup, a fair trade happening every two years triggering many contracts or any major non-company dependant events need also to be part of this "initiative" forecast. You can also think about special events even if they are recurring every year but at another date, like "black friday" and "cyber monday" sales at the end of november every year.
These "special events" can have a huge impact on your initiative forecast and sales volumes can be multipled or divided strongly. Getting a calendar of the most important events which will impact your sales volume next to you is key when you start building an initiative forecast. Pricing analysts in airline companies such as Air France start their day by reading the press, to understand which are the events which are likely to impact the sales volume - and adjust their rate card consequently.
A tedious but necessary job
Integrating incremental forecast can however be a very complex topic: the best thing to do - and this is purely a finance job - is to gather all the business plans throughout all the company departments, to back them up, check them, vet them and aggregate the revenue associated up. This requires to have all the business cases following a strong methodology, with reliable assumptions and realistic projected outcomes. The more the company will have projects and initiatives on their roadmap, the hard the initiative forecast job will get and the harder the realization will be.
Strong marketing budget modifications need to be factored in. Imagine you will be increasing your overall marketing spending by +10% throughout the year with an expected outcome, for instance, if you plan to introduce a new customer acquisition channel. Then this incremental spending will drive incremental revenue throughout the company and it has to be factored in the incremental part of your sales forecast, associated of course to the relevant initiative you're trying to forecast.
What to do once you have your incremental and baseline forecasts?
Forecasts guide the activity
This combined forecast will be the guide to analyze the performance of your company. What is success will be defined against these KPIs and budget. Sales people will receive payouts and bonus according to this number. Financial ratios will depend on this topline number. While year over year comparison and usage of tools like CAGR are great to measure the success of a company, measuring the actuals versus budget is what ensure that the company is basically delivering against what's been planned and committed at the beginning of the year.
It also allows to quickly course correct any bad performance and to put in place quickly an operational plan to improve the efficiency usage of your people and financial ressources to meet your goals.
Forecast at a granular level
The more granular your combined organic + initiative forecast will be, the more efficient should be your business monitoring. With a granular forecast, you should be able to identify quickly what is over performing and what is under performing. What are the initiatives who have success - and which are the laming ducks where you need to focus.
You should keep a close eye all along the year on the performance (actuals) generated by the incremental projects. A delay in execution or a wrong early stage assessment can directly impact the accuracy of your forecast. Tableau Software, Qlikview or PowerBI are great business intelligence tools helping building automated reports. Just make sure to invest the right amount of time setting up these reports.
Keep track of performance
Measuring "contribution to growth" is also key to capture dynamically the key drivers. Contribution to growth breaks down the global year over year growth rate into all weighted dimensions. If you want to understand more about contribution to growth and how to calculate it, you can read our post on it. CTG factors is a prorata of growth points for each dimension, depending on their overall size. Contribution to growth monitoring will help you control your baseline performance.
If you need to quickly build a baseline forecast, your should spend some time reading our product page: this might capture your interest.