Question

evenue forecasting is an extremely important function of the budget process. What are some of the reasons forecasting appears to have become more difficult over the past several decades and what are the consequences of (ADDRESS BOTH) underestimating and overestimating revenues.

Answer 1

Reasons of revenue forecasting being difficult exercise-

1. Ever changing economy - Economy is changing dynamically and there are a lot of factors causing it. It is practically impossible to predict the changes that will happen in near future, which can cause forecast numbers to be different than reality.
2. Competition- Market has multiple options for consumers to choose from. Economy has become customer oriented and catering to their demands has become top priority of all the companies. With so many players competing in market space, it is difficult to get revenue forecasts right.
3. Limited data - Companies don't have adequate tools to capture data from market, which can lead to inaccurate forecasts. In absence of adequate market knowledge, managers won't be able to incorporate effects of changing market dynamics into forecasting process.
4. Inflexibility in forecasting process - Forecasts are not flexible to cope with changes. They are build on one set of assumptions. It is better to make forecasts taking into consideration all courses of changes and then take decisions accordingly..

Consequences of underestimating and overestimating revenue-

Underestimating revenue from an activity can cause less resources being spent on the same. If more resources would have been allocated, it is possible that company would have been able to tap more revenue by tapping the opportunity.

Overestimating revenue can result in more resources being dedicated to a particular line of business or activity, which is overestimated to generate more revenue. It can lead to resources being deviated from other project, which could have generated more revenue.Costs can increase if resources are getting wasted. Not only that, it can cause loss of time,which could have spent on other more productive activity.Another outcome can be costs not getting covered by the revenue generated, which can end in financial difficulties or budget deficits.

Addressing over and underestimation -

One solution is to make better estimates by creating a flexible budget rather than static budget, which will take all future courses of action into consideration. Overestimating revenue is more problematic than underestimating revenue is. Training should be given to the people involved in the process, so that they give more probabilistic estimates.