categoryBudgeting and Forecasting

Remedies for Forecasting Illnesses

Yesterday I wrote about the seven common symptoms of forecasting illness and how they can lead to uninformed decisions making. In an increasingly volatile and uncertain world, the ability to anticipate the future, even if only a few months ahead, can mean the difference between survival and failure. Unfortunately, future uncertainty is much greater than most managers concede. Thus if managers fail to demonstrate an understanding of the dynamics of their businesses performance stakeholder confidence can seriously be undermined. As a result, managers must place an increasingly high priority on improving their forecasting processes.

How can managers use forecasting tools to plan effectively and build better strategies? Instead of seeking predictability, managers should channel their efforts into being prepared for different incidents and the reality of change. Take for example the Global Financial Crisis of 2008. Prior the financial meltdown, majority of global policy makers and business leaders were very upbeat about the performance of their economies despite signs of looming danger. Not many people anticipated the after effects of a global financial system collapse on their businesses and as a result some reputable organizations collapsed and filed for bankruptcy while others were bought over for at cheap market values.

Volatile markets make it enormously difficult to forecast effectively. However, although many things that occur in the business world may not be predictable, their randomness should at least be modelled. For example, there are bubbles, recessions, financial crises and natural disasters which are known not occur very often but do repeat at sporadic and irregular intervals. While leaders, managers and employees are reasonably aware that these rare events can occur, and may even be able to imagine several examples, they consistently underestimate the likelihood of at least one such event including the ones they didn’t imagine occurring. This is because human beings have a tendency to underestimate the size of rare events, which in most cases, leads to negative consequences.

It is not only business catastrophes that producers of forecasts fail to anticipate. They are also unable to predict business success. For example an unhealthy obsession with a particular forecast number as well as the failure to provide enough forward visibility and discern trends in performance makes the business to miss on emerging opportunities. When preparing forecasts; managers should accept that they are operating in an uncertain world, assess the level of uncertainty they face and augment the range of uncertainty.  It is critical to have the ability to perform “what if” scenarios and change analysis. Additionally, managers should be able to re-forecast as market conditions change. This will protect managers from having a single tunnel vision about the business which in turn helps them formulate appropriate strategies to deal with rare events when they occur.

To address their forecasting shortfalls, some organizations believe that investing in latest software tools will solve their problems. Unfortunately, the application of IT solution without understanding the real problem and its source will not fix a broken forecasting process. For example, some managers believe that investing in some sort of trendy software will help them collect, consolidate and analyze forecasting data quickly enough.  This is just a quick fix which often leads to lots of numbers, gaming behaviour and wastage. If you do not first solve the root cause of the problem, there will be no reprieve.

The other quick fix that other managers resort to involve using complex statistical methods hoping that these will help them better anticipate the future. Human judgement is worse at predicting the future than are statistical models. In fact, human beings are often extremely surprised by the extent of their forecasting errors. Thus instead of using simple statistical models to forecast, some managers are preoccupied with applying complex models. Simple statistical models such as moving averages are better at forecasting than complex ones. Complex models often attempt to find non-existent patterns in past data whereas simple models ignore patterns and just extrapolate trends.

The benefits of getting your forecasting right are considerable both in terms of improvements in efficiency and effectiveness. Better forecasting results in informed decision-making. Right things will be done at the right time – there will be no surprises as well as wastage of time and resources. Improved forecasting also leads to better situational awareness which helps the organization to spot discontinuities early, avoid unnecessary costs, formulate fitting contingency plans, become agile and exploit opportunities.

Good forecasting also enhances teamwork and collaboration. If sales, marketing, operations, finance etc. are all involved in the forecasting process this leads to one set of numbers being produced and agreed upon instead of having numerous competing forecasts. Lastly, by anticipating better and responding more quickly, the performance of your business will become more certain and less prone to surprises.

I welcome your thoughts and comments.

 

 

7 Common Symptoms of Forecasting Illness

When making decisions, managers should not rely only on information about what happened in the past. They also need information about what they believe will happen now and in future. Effective decision-making is driven by information, information about the past and information about the future. This information is often created through the process of forecasting. Without this information, management is no more than guesswork.

In today’s volatile and uncertain environment, it is difficult for any organization to survive without some sort of ability to anticipate. Simply forecasting better is not enough. You have to know what actions to take if the picture your forecast point is negative. Thus you need to clearly understand the link between forecasting and decision-making. Bad or poor forecasts can misinform decision-making and derail the company.

It is a known fact that no one can predict the future with certainty. Instead, good forecasting is about systematically and logically amassing information to give managers forward visibility of likely outcomes, potential risks and opportunities. If your organization’s forecasting process is not granting you the clear visibility you need to make informed decisions, this is a sure sign that the process is broken and needs repairing. While the importance of forecasting is well documented, in practice it is rarely performed well, sometimes with disastrous consequences.

In their book Future Ready: How to Master Business Forecasting, Steve Morlidge and Steve Player point out seven common symptoms of forecasting illness that need fixing and these are:

  1. Semantic Schizophrenia. This refers to confusion about the aims, purposes and characteristics of good forecasts. Organizations suffering from this condition often find it difficult to cope with unexpected or unwelcome forecast outcomes. In these organizations, bad news is not welcome. Instead, leaders want to hear only good news. Thus instead of producing forecasts that reflect the truth, employees tend to produce forecasts that reveal what managers want to hear to avoid being yelled at. These employees believe they are always fighting a losing battle hence producing forecasts that makes the managers happy. If they deliver forecasts with bad news, the level of stress associated with this is astronomical hence delivering good news only minimizes these stress levels.
  2. Single Point Tunnel Vision. This is an unhealthy obsession with a particular forecast number. Everything that lies outside this particular forecast number is considered wrong and the more precisely it is stated, the more wrong it will be. In these organizations, executives are always debating about what the forecast numbers should be. There is no thinking outside boundaries and assumptions are not challenged often resulting in poor judgement and decision-making.
  3. Delusions of Accuracy. This is the mistaken assumption that it is possible to be perfectly accurate and that lower errors are representative of better forecasts. Managers are obsessed with achieving forecast accuracy and people feel that they will be punished for getting forecasts wrong. When forecasting, it is important to know that forecast errors are inevitable. There will always be error and sometimes the error will be greater as a result of the factors that are outside the control of the individual performing the task. It is therefore critical to make a distinction between error that is the result of random fluctuations and error that may be the result of poor forecasting. Good forecasts have a reasonable margin of error factored in.
  4. Nervous System Breakdown. This is a misguided attempt to improve forecasts by going into more detail and analyzing forecasts obsessively. Are your organization’s forecasts way too detailed? Is there always pressure to provide more details and more analysis? In today’s world of big data, it is imperative to understand that having more data does not always mean better decision-making. At the same time, more and more analysis does not mean revelation of the truth. Remember all forecasts are made up of assumptions rather than facts. Thus if the majority of your assumptions are wayward, no matter how much analysis you do, wrong decisions will be made with devastating consequences.
  5. Visual Impairment. This refers to the failure to provide enough forward visibility and discern trends in performance. Organizations that suffer from this problem focus entirely on the year-end forecast numbers to the marginalization of everything else. There is significant inability to see beyond the year-end, track trends and therefore make reasonable projections. This inability to see beyond the financial year-end often results in these organizations becoming vulnerable to shocks in the early months of the new financial period since they do not have sufficient time to take defensive action. This problem is particularly prevalent where financial incentives are tied to the achievement of annual goals.
  6. Lack of Coordination. The tendency to generate a large number of competing forecasts. In these organizations, there is enormous conflict, chaos and continual fire fighting between the different functions of the organization. For example, the way sales, operations and finance view the future is considerably different which in turn results in employees from these functions exhibit uncoordinated behaviour which makes it difficult for the organization to function effectively and efficiently towards the achievement of strategy. When your organization has a number of competing forecasts, performance cannot be sustained.
  7. Socio-Pathological Behaviour Patterns. This refers to involuntary encouragement of behaviour patterns that are damaging to the forecast process and to the health of the organization as a whole. In such organizations, there is widespread manipulation and distortion of information. Employees withhold knowledge until the truth becomes impossible to disguise or deliberately provide misleading information to managers and other decision makers. Forecasts are biased for fear of recriminations. In turn, unknowingly, managers reward bad behaviour by mistaking fabricated forecasts for good performance. This problem is predominant in environments with a culture that unwelcomes nasty surprises, punishes employees for telling the truth and rewards them for lying.

What are the other common symptoms of forecasting illness you have experienced?

I welcome your thoughts and comments.

Breaking Free From the Shackles of the Annual Budgeting Process

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.

Implementing Rolling Forecasts

In order to survive and drive business performance in today’s increasingly competitive and turbulent economic environment, organizations must be able to anticipate changes and be adaptive. Traditional annual fixed budgets no longer play the tricks. Instead, organizations need to implement new forecasting techniques capable of helping them anticipate changes and better inform strategic decision-making.

Avoiding total reliance on the annual budgeting process to monitor and drive business performance and implementing rolling forecasts can help business leaders steer their organizations in the right direction in these volatile and uncertain times. Rolling forecasts help organizations obtain reliable and relevant insights on enterprise risks and opportunities; identify and forecast the key business drivers continuously; evaluate business strategies and effectively and efficiently align organizational resources and processes for competitive advantage.

To successfully implement rolling forecasts, organizations must:

Base Forecasting on Key Business Drivers: Abandoning the fixed annual budgeting process requires business leaders completely making the decision and committing themselves to move towards the use of driver-based forecasting. Although no forecast is 100% accurate, forecasting business performance should not be done on gut feel, otherwise the results will be disappointing. To avoid actual performance deviating further away from forecast performance, all the key drivers of the business that are relevant for decision-making and informing strategic direction must be identified first. These drivers are both internal and external and help the business remain on top of market changes and challenges. This in turn improves organization-wide alignment, forecasting control and decision-making processes.

Align Forecasting With Strategic and Operational Decisions: One of the main objectives of forecasting is to evaluate business strategies, align organizational resources and processes efficiently and reduce inefficiencies.  Since the use of rolling forecasts helps the organization to continuously evaluate its operating environment, business leaders are to perform “what-if” analyses and evaluate current strategies under different scenarios. This in turn helps formulate alternative strategies, allocate capital and operational resources effectively and set new targets. Priorities are redefined for the operative processes, and adaptation measures and activities are proposed by operational managers.

Create Ownership of the Forecasting Process:  Organizations that have successfully implemented rolling forecasts have done so because they involve the various budget owners in forecasting. Directly involving budget owners in forecasting helps decision makers get a broader and more accurate view of the organization’s current position and future outlook since each budget owner is approaching the process from a different perspective. Furthermore, they have not viewed forecasting as a process done to adjust the annual numbers to fill the gap and meet the targets. They view forecasting as a continuous improvement process that is driven by changes in the organization’s playing field.

Implement Technology That Supports Driver- Based Forecasting: Since rolling forecasts work on various assumptions, there is need to invest in a system that can easily analyse, interpret, integrate all this information and play different scenarios to ensure sound decision-making. Data and analytics are essential for rolling forecasts. Organizations that want to make the transition must focus on relevant data and data-related processes. Predictive analytics can help analyze historical and current internal and external data, show what is happening and predict where the business is heading.

Embrace and Drive Process Change: Moving from the fixed forecasts to rolling forecasts is a cultural change initiative that requires proper senior management. It is therefore important for management to design an appropriate change management policy that is capable of driving the process change. For example, the change policy must clearly explain the reasons for changing, the communication procedures, the measures of success etc.

Qualities of a Good Forecast

The business economic environment as we know it is never the same all the time. Volatility is the norm. Commodity prices, foreign exchange rates, interest rates, inflation rates, population figures, unemployment figures etc are constantly falling and rising.

All these indices have a bearing on business performance and with such high levels of volatility, the ability to make accurate predictions and act on them differentiates the winners from the losers.

During earnings reporting periods, for example, it’s not rare that we hear news of certain organisations meeting their forecasts and others failing to meet their estimates.

Within various organisational departments, there are massive teams busy forecasting business performance and other indicators. It is true that no one can accurately predict the future, but then, it is better to be close to the future than be far away from it.

For example, having an idea of who your most profitable customers or products and the revenues they bring is better than not knowing at all as this helps with planning and deciding on whether to channel extra funds to other investments.

Understanding what makes a really good forecast is key to meeting business targets and enhancing your competitive advantage.

  • Forecasting is about decision making and understanding the businesses future. It’s about creating and shaping the organisations’ future.
  • The frequency of preparing business forecasts should be driven by the rate of change in the key variables such as revenues, labour costs, travelling costs, advertising costs, telephone and other operating costs.
  • Business forecasts should be free from bias and should have an acceptable level of variation.
  • The accuracy of business forecasts depend on the ability of your business to properly keep records. There should be readily available data on what has occurred in the past and what the situation appears to be in the present.
  • Good forecasts are not based only on accounting figures but also take into account local and global economic activities.
  • Forecasting and planning are closely related. Your business forecast should come with plans of what you intend to do to achieve your targets.
  • Do not rush to paint a picture of the period ahead without analysing all the facts. Have different possibilities and analyse your business under the worst case scenarios and have strategies in place to weather those conditions.

Taking into account the above will help you place your business in a better position to seize future opportunities and avoid suffering huge loses in the future.

Planning to react after the future unfolds is insufficient, instead, you need to act ahead of time so as to shape the future.

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