Assumptions are an integral part of estimations and projections. It is often necessary to piece individual pieces of information together to build a bigger picture, and each component of an estimate is likely to involve some form of assumptions regarding its validity or magnitude. This article explores the importance of being clear in these assumptions – carefully documenting them as part of your calculations so that you and others are able to understand the basis for your calculations.
Why is it important to be clear on assumptions?
Allows you to keep track of the basis of the calculation
The first reason to be really clear in stating your assumptions when making any form of financial estimation or projections is that it allows you to keep track of the basis of your estimations. When you initially make an estimate, the assumptions may be clear in your mind – over time though, they may get forgotten – suddenly some back-of-the-envelope calculations with substantial uncertainty start to be taken for granted. The assumptions are forgotten, and the estimate is taken as fact.
Keeping all of the assumptions clear on your workings helps avoid that – it reminds you of the basis by which your estimates were calculated, and allows you to revisit those assumptions at a later point in time.
Share the basis of the calculations with others
Being clear of the assumptions on your workings also enables you to explain and justify the calculations to others. Rather than numbers appearing out of nowhere, if you have assumptions clearly stated, you are able to discuss your estimations with colleagues.
Mistakes can get identified
Having assumptions clearly documented also makes it easier to identify mistakes with the calculations. If you have everything laid out clearly, you and others can more easily review the assumptions – making sure that they seem reasonable. For assumptions that appear particularly uncertain, you can then seek further information – looking to triangulate your assumptions to increase the confidence of your estimations.
Provide greater confidence in the estimates
Having clear assumptions can also increase the confidence that you have in your estimations. There are times where if the assumptions are very strong and widely agreed, then the estimation you are working towards becomes self-evident. If you and your team all agree with the underlying assumptions underpinning your estimates, then confidence in the final estimate is greatly improved. Being clear about how you have come to the estimation allows others to understand the approach – and if the approach makes sense, then their confidence in the final number is likely to be much greater than from just presenting the top-line figures.
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