Structuring the Revenue Forecasting Process

1 Structuring the Revenue Forecasting Process Forecasting is very difficult, especially if it is about the future. Niels Bohr, Physicist, Nobel Prize winner, 1922. By Shayne C. Kavanagh and Charles Iglehart F. inancial Forecasting , which defines a government's STEP 1: DEFINE THE PROBLEM. financial parameters, is one of the finance officer's The first step in the Forecasting Process is to define the fun- most important tasks. Accurate Forecasting also fore- damental issues affecting the forecast, providing insight into warns a government about financial imbalances, allowing it to which Forecasting methods are most appropriate and how the take action before a potential imbalance becomes a crisis, and forecast is analyzed, as well as providing a common under- forecasts can promote discussion about the future and how the standing as to the goals of the Forecasting Process .

2 It will also organization might develop long-term plans and strategies. help the forecasters think about what their audience might be This article describes a step-by-step approach to conduct- interested in. While each local government will have distinct ing Revenue forecasts in local governments. As Bohr said, issues to consider, there are three key questions that all gov- Forecasting is not easy but a structured approach can help ernments should consider as part of Step 1. forecasters ask the right questions, given the environment What is the Time Horizon of the Forecast?

3 The time and audience; use the most appropriate techniques; and horizon affects the techniques and approach the forecaster apply the lessons from one round of Forecasting to future will use. For example, short- and medium-term forecasts rounds. Structuring the Forecasting Process provides the fol- demand higher levels of accuracy because they will be used lowing potential advantages: for detailed budgeting decisions. Longer-term forecasts are n orecasting is easier to replicate each year, leading to F used for more general planning, not detailed appropriations.

4 Greater organizational learning. Also, some Forecasting techniques lend themselves better to n he Process is transparent and relatively easy to explain T shorter- than longer-term Forecasting , and vice versa. Longer- to others, which should make it easier to get others to term forecasts will benefit from presentation techniques that accept the forecasts. emphasize the degree of uncertainty n ecause a structured Process B inherent in the forecast and the choic- encourages the forecaster to The first step in the Forecasting es decision makers face.

5 Adhere to Forecasting best practic- Process is to define the fundamental Is Our Forecasting Policy es more diligently than an unstruc- issues affecting the forecast. Conservative or Objective? An orga- tured method would, the results nization can adopt one of two basic should be more accurate. policies on how Forecasting will be The GFOA has adapted the follow- conducted. A conservative approach ing Forecasting approach from the systematically underestimates rev- advice of leading forecast scientists1 and the experiences enues to reduce the danger of budgeting more spending of public finance practitioners and academic researchers.

6 Than actual revenues will be able to support. An objective . It involves the following steps:2 approach estimates revenues as accurately as possible. 1. Define the Problem. What issues affect the forecast and Some public officials prefer conservative forecasts, which presentation? reduce the risk of a Revenue shortfall. But this kind of forecast 2. Gather Information. Obtain statistical data, along with can also cause unnecessary fiscal stress during the budget accumulated judgment and expertise, to support fore- Process as the organization closes a fictitious Revenue gap.

7 At casting. best, the government will incur opportunity costs, losing out 3. Conduct a Preliminary/Exploratory Analysis. Examine on the benefits that could have been realized from programs data to identify major drivers and important trends. This and projects not undertaken. At worst, this approach could establishes basic familiarity with the Revenue being fore- lead to unnecessary lay-offs or other disruptive cuts. Further, cast. overly conservative estimates could lead to lost credibility 4. Select Methods. Determine the most appropriate quanti- as budgeting personnel become increasingly weary of the tative and qualitative methods.

8 Pseudo-financial stress. 5. Implement Methods. Use the selected methods to make The downside of an objective approach is a greater chance the long-range forecast. of experiencing an actual Revenue shortfall during the year October 2012 | Government Finance Review 9. and, thus, incurring actual fiscal stress during the course of ible, reliable future values available? For example, Fairfax the year, as the budget has to be adjusted. Organizations County, Virginia, gets estimates of future employment in the that pursue an objective policy of Revenue estimating should area from a third-party economic analysis firm.

9 State and develop policies and practices to guard against these risks, federal government agencies and universities will also often such as budgetary reserve policies and contingency plans. provide estimates of future values for select indicators. The Association for Budgeting and Financial Management main- Are We in a High or Low Growth Environment? Land tains a database of state and local economic and financial uses underpin the fiscal health of local governments. Forecasters indicators that can be accessed by the general public. should consider if their community is experiencing:3.

10 N igh growth and development the rate of population H Gather Inside and Outside Special Expertise. The growth is increasing each year. finance officer should access special expertise from both inside and outside of the organization to improve forecast- n Moderate growth there is growth, but the rate is declining. ing. People who are not part of the organization can provide n ow growth population is declining or flat, or the rate L technical skills or resources that aren't available in-house or of growth is negligible. aren't economical to maintain, or they can simply provide Each of these categories has different implications for the an outside perspective.