Budget forecasts are almost always wrong; it is just a question of by how much, and in which direction. The ways in which finance officers handle the risk of a forecast being wrong can have a real impact on their credibility and the quality of the budgetary decisions made by the chief executive officer and/or governing board. Two variables affect the accuracy of a forecast: the inherent uncertainty of tax (or other) revenues, and the extent to which that uncertainty is taken into account by decision makers. Many people think good forecasting is simply a matter of accuracy — that is, making precise predictions that are used to inform the development of a given budget. But in practice, good forecasting also involves an element of education. The likelihood of different scenarios should be conveyed, and the consequences of budgeting mistakes should be transparent.
This article will show how several cities are using spreadsheets to bring sophisticated risk awareness to municipal finance. They demonstrate that finance officers don’t need to choose between giving budget decision makers a conservative forecast and a best estimate. Instead, by explicitly recognizing the uncertainty in forecasts, finance officers can improve their dialog with decision makers and arrive at a budget that makes the best use of all available resources, while mitigating the risk posed by revenue shortfalls.