It is a fact that no one can predict the future with certainty. But does this mean that the management teams need to steer their organizations with a rear view perspective? The answer is a big NO. Management need to at least anticipate different future scenarios that the organization is exposed to and formulate effective strategies capable of addressing this uncertainty.
Unfortunately, most organizations remain tied up to the annual budgeting process. They spend months drafting the budget and then monitor performance against it. The problem with monitoring performance against the annual budget is that it makes managers focus more on hitting the numbers at the expense of the long-term interests of the business.
Instead of taking a long-term view of enterprise performance and considering all the factors (Qualitative, Quantitative, Financial and Non-financial) that can help management make effective decisions, trapped into the shackles of the annual budgeting process, management end up making short-term tactical decisions that have devastating effects in the long run. Sometimes they just add a percentage point (for example, the inflation rate) to last year’s budget numbers to get to the current year’s budget numbers. The problem with this approach is that it ignores all the other important drivers of value creation and their impact on business performance.
By the time the separate business units submit their budgets for consolidation, most of the assumptions used to prepare these budgets are no longer valid. So what should organizations do in these turbulent and uncertain times? Instead of waiting for the future to present itself and then react to this future, organizations need to be proactive and adaptive. Sketching the future with a range of likely outcomes based on a variety of options helps managers make confident decisions and also enables the organization to respond rapidly to unpredictable events that can easily erode value overnight.
As clearly stated above no one can predict the future with certainty. I am not advocating that managers predict these events accurately. Instead, managers need to continuously look ahead and use all the information at their disposal to formulate decisions that maximise the potential of the business. This will in future help evaluate the alternative courses of action available to deal with negative events when they happen.
It is important to note that effective decision making is driven by information. The information needs to be timely, accurate and of reliable source. Today, various business intelligence and analytic tools can be used to capture, store, analyse and interpret vast amounts of data for sound decision making. When making strategic, operational and tactical decisions, management need not rely only on information about what happened in the past. They also need information about what they believe might happen as well and this information comes about as a result of effective forecasting.
Implementing scenario planning, rolling forecasts and driver-based forecasts helps management escape the perils and consequences of the annual budgeting process. These tools help managers organizations anticipate the future, steer their organizations in the right territories and in turn drive business performance.
Without some ability to at least anticipate the future (For example changes in regulations, the economic environment, customer tastes, social attitudes, technological developments, political environment, competition and other industry and market dynamics.) it is difficult for the organization to survive. It is therefore important for managers to transform their planning and forecasting processes if they are to succeed in strategic execution, risk management and performance management.
Breaking free from the ropes of the annual budgeting process requires management to view the planning and strategy execution with different lenses. It is all about strategic change management. They need to present a strong case throughout the organization on why the current processes have run their course and need transformation. Effective forecasting is not a Finance function alone. Input from other functions is critical to enable a 360 degree view of the organization and drivers of value creation. Some of the factors pointing to the need to move from the static budgeting process to rolling forecasts and driver-based forecasting include:
- Rapid changes in the modern economy. Today organizations can rise up quickly and at the same time disappear overnight because of failure to anticipate the future. The global economy and its organizations are now so interconnected that it can be dangerous to make wrong assumptions about the business environment more than a few months ahead.
- Effective forecasting shields the organization from the drastic effects of today’s turbulence and uncertainty. Sometimes it is not the case that the organization is weaker or that the market is underperforming that leads to failure. It is simply that the systems management is relying on for decision making are outdated. Being unable to effectively forecast and respond to the future exposes the business to serious risk of loss and in extreme case failure.
- Growth in amount of data. Amount of data available has increased. Adding a percentage point to last year’s numbers is misguided. It fails to take advantage of all the structural and non-structural data that plays an important role when it comes to effective decision making. Effective forecasting systematically and rationally helps managers assemble information that gives them visibility about what lies ahead in terms of likely outcomes, potential risks and opportunities.
- Increased shareholder expectations. As providers of finance, shareholders are constantly looking for a satisfactory return on their investment. Should the organization fail to deliver on this it is most likely to see the back of its financiers. The investment community is always looking for quarterly feedback in the form of earnings reporting. Thus the assumptions used in the annual budgeting process need a constant assessment as failure to do so can leave the organization with an egg on its face. A profit warning as a result of failure to anticipate the future can drive down organization value immensely.
It is therefore important for managers to have a reliable projection with some ranges around it, a reasonable idea of the drivers of uncertainty and a compelling plan of how they intend to mitigate risks or exploit opportunities.
As the modern business economy continues to evolve managers must recognize the drawbacks of the annual budgeting process and importance and advantages of effective forecasting. It is also important to take advantage of credible EPM technological solutions in the market, if implemented correctly, allows managers to see over the horizon. These systems also help provide real time information that can be used for effective strategic decision making.
I welcome your feedback and comments.