Inflation, higher interest rates, rising bond yields and concern about when another recession might arrive are all contributing to an uncertain economic outlook despite a favorable stock market through the first three quarters of 2023.
In this time where accurately identifying what’s next for the economy is a speculative exercise, there is still a bit of good news for community bankers. Budgeting and forecasting, an annual process that many dread, may not be the best tool in this or any economy. To be truly agile, more accurate and up to date, more CFOs are turning to rolling forecasts.
How rolling forecasts work
A rolling forecast, according to U.S. Analytics1bit.ly/USAnalyticsRollCasts, is a type of financial model that predicts the future performance of a business over a continuous period, based on historic data. It uses a rolling, “drop/add” approach to data analysis in which the oldest information in a fore casting model is automatically replaced with data from the most recent, corresponding timeframe.
To put it simply, let’s look at a hypothetical one-year rolling forecast updated monthly. The first forecasting data covers the prior January through December time frame. One month into that model it would automatically drop January and update information to encompass February through January, then March through the following February and so on.
Unlike a traditional model, this ongoing process allows continuous, more accurate forecasting. It works because regular updates help community bankers anticipate specific needs and implement appropriate actions more effectively than static sets of data.
Better positioned to address market changes
Rolling forecasts give bankers greater agility to react in real time to changing economic conditions. For instance:
- Improved accuracy. One top complaint about traditional yearly forecasting is that by the time they’re completed, the information is no longer accurate. Even in the most stable of times, there are variables like interest rate adjustments, competition, branch resizing, increased lending and other factors that inherently fluctuate. A rolling forecast improves the accuracy of financial planning by keeping bankers aligned with business environment changes.
- Updated information. CEOs expect CFOs to help drive profitable growth, and success depends heavily on accessing and analyzing up-to-date performance information. Consistently high-performing banks are intentional about performance management. They follow a cycle that relies on frequent forecasting to drive strategy and future results.
- Reduced risk. A more accurate forecast reduces overall banking risks. Market changes often happen with little to no warning and such volatility can negatively impact a bank’s bottom line. A rolling forecast helps bankers adapt to changes quickly and reduce their institutions’ exposure to adverse impacts.
- Untapped opportunities. If the business environment has changed favorably since their last forecasts, bankers can adjust assumptions and evaluate how their projections could be affected by strategic changes. For example, if deposits are up, banks may be able to increase loan volume without buying funds and seize profit-making opportunities (perhaps a 20-30 basis point lift in net interest margin) sooner than if using a non-rolling model.
- Shortened budgeting process. Many people believe that annual budgeting is so fraught with flaws (and universally disliked by banking professionals) that it should be replaced with rolling forecasts. While many community bankers may not be ready to do away with their annual processes, they may want to consider that rolling forecasts could cut budgeting times in half.
- Increased efficiencies. All the aforementioned benefits combined offer more accurate, efficient forecasts. The data mining burden on CFOs is reduced significantly, empowering them to become data interpreters. As such, they have greater agility to identify market changes and the ability to adjust their respective approaches more rapidly.
Unlike giant financial institutions, community banks can ramp up and make quick decisions for more immediate responses to changing and often unpredictable economic conditions. The key is utilizing a rolling forecast, rather than inflexible annual projections that are set in stone before anyone knows what changing conditions may entail or what response is appropriate. It’s a tool to help smaller banks stay competitive with the bigger institutions, making it a win-win for bankers and customers alike.
