Forecasting and business performance

(Conclusion)
The changing face of forecasting

Decrying the focus on historical data and financial risks is easily done but Parker is quick to point out that this is how the forecasting process has worked for years. Breaking out to suddenly consider non-financial risks for example is not going to happen overnight.

He continued: “In addition, there is a massive conceptual problem in deciding how to address and quantify the impact of non-financial risks when creating a forecast. This is not an issue which forecasters have traditionally been comfortable with addressing. Indeed, one survey respondent recalls organizations preferring to change its economists rather than address difficult-to-quantify risks.”

“In some quarters, scenario planning is seen as the answer. Going forward, surveyed organizations clearly wish to enhance forecasts to take account of uncertainty. In particular, they seem interested in using more scenarios to prepare better for the vagaries of the future.”

Such scenarios add a valuable new perspective to forecasting. By running numerous different scenarios, risks and opportunities can be more easily measured. The process also facilitates the development and — if necessary — the implementation of contingency plans for when those risks become a reality.

Another recent development in the forecasting world has been the use of rolling forecasts. Increasingly popular as a way of helping to ensure that organizations keep pace with a rapidly changing business environment, usage of these is more prevalent amongst the better performing companies within the survey base.

Rolling forecasts are able to adapt to new information, giving their users a competitive advantage over those who persist with rigid, static forecasts. They are also seen as one of the best ways of keeping expectations reasonably in line with those of the market.

The culture of forecasting

Human nature is a terribly difficult thing to change. Yet it is human nature which is mainly to blame for the fact that so many companies appear to underplay their forecasts. Sometimes called “sandbagging”, “low-balling” or “gaming”, there is a definite tendency to under-play forecasts in order to comfortably exceed them.

Bonuses and reputations are thereby protected — and often it is the company structure itself which creates this situation in the first place by placing so much pressure on employees to hit targets. Accuracy thus becomes one of the prime casualties of this particular battle.

Parker believes that two problems arise from this. “Firstly,” he claims, “investors and analysts are not stupid and will quickly pick up on companies which are consistently falling into this pattern of under-forecasting; and will amend their view of that company accordingly. Secondly, poor forecasting can lead to poor decision making.”

“The latter point is arguably the bigger issue and is one which needs concerted action from senior management to address.”

“Traditionally, “making budget” has been a key measure of performance and therefore a key behavioral driver. Eliminating this link can eliminate the gaming which occurs when rewards and incentives are tied to budget performance.”

“Linking incentives to relative performance (e.g., market performance, external and internal peers or key economic conditions) rather than meeting a budget that was set months ago is a significant enabler to changing behavior.”

As well as addressing cultural issues, leading forecasters apparently treat forecasting as a discipline. They treat it as a key management process, involving the right people. They instill a culture that facilitates quality forecasting. They align incentives to relative performance rather than targets.

In doing so, they are able to change the perception of the forecasting process from something which is an inconvenient waste of time into something which is a means of generating data that is important for the successful management of the organization.

Agility, vision and communication

If an organization is able to master the modern day approach to forecasting, the potential benefits are numerous. Reliable financial and business projections are just one part of it. A company can benefit from greater agility; the ability to quickly sense and respond to changes in the dynamic business environment.

There will be increased transparency around future business opportunities and an improved ability to manage uncertainty and risk.

There will be an improved basis for dialogue with external stakeholders, enhancing trust and increasing confidence. Finally — perhaps most importantly — there will be the chance to increase shareholder value.

In the face of all this, maintains Parker, “Trying to argue that consistently poor forecasting doesn’t really matter is a forlorn hope. It really does matter.”

(Marianito D. Lucero is a Principal in the Business and Financial Advisory Services of Manabat Sanagustin & Co., CPAs, a member firm of KPMG International, a Swiss Cooperative. This article is for general information only and is not intended to be, nor is it a substitute for, informed professional advice. While due care was exercised to ensure the quality of the information contained in this article, readers should carefully evaluate its accuracy, completeness and relevance for their purposes, and should obtain any appropriate professional advice relevant to their particular circumstances. For comments or inquiries, please email [email protected] or [email protected])