Although almost every organization uses forecasts to predict and manage future business performance, only a few of the produced forecasts are reliable despite the amount of energy and time invested in producing them. The problem with unreliable forecasts is that they have far-reaching strategic and operational implications.
They lead to poor decision-making which in turn costs the organization a lot of money. Analysts from the investment community closely monitor the forecasting capabilities of the companies they track. Failure to hit forecast targets can result in the share price getting hammered and eventually a “sell” call by the analysts. This has negative repercussions on the market capitalization of the organization. Of course no one can accurately predict the future. However, producing forecasts that are within five percent of the actual performance is considered accurate.
Accurate forecasts are a potential driver of business performance and investor confidence. They help identify opportunities to drive business improvement, manage risks, determine growth strategies and reinforce stakeholders’ confidence in the business. One of the reasons why so many forecasts lack reliability is because the data used to produce these forecasts is either erroneous or incomplete. For example, some organizations depend largely on internal data to predict future performance at the expense of external data such as consumer demand, competitor activity, economic drivers etc.
To be able to forecast with confidence, it is imperative that those individuals tasked with the forecasting responsibility leverage information more effectively. In addition to internal reports, they should make use of government reports, market reports and competitive data as well as data on non-economic risks that could have important impacts on markets or operations to produce forecasts. Also, operational managers who are closer to the business scene must be involved in the forecasting process.
There is a mistaken belief that forecasting is the sole responsibility of finance. Surely finance plays the leading role, but it is important to give the operational managers that drive business performance greater ownership and responsibility for key parts of the forecasting process. By constantly liaising with their operational counterparts, finance will be able to quickly pick up changes in the business operating environment, perform what-if-analysis, update their forecasts accordingly and provider better insights that assist executives make informed decisions.
Despite the advent of reliable forecasting software, there is still a huge reliance on spreadsheets by a majority of organizations to produce forecasts. Although it is possible to produce reliable forecasts using spreadsheets, this is dependent on the size of the organization or business. As the business grows, it becomes increasingly difficult to continue sticking to spreadsheets. This is because spreadsheets are great for building a single department budget and forecast but don’t work well for rolling up the budget and forecast for tens of departments and divisions.
Furthermore, spreadsheets are more prone to errors. Poorly constructed spreadsheets make it worse by mixing formulas and data so it is easy for users to type over formulas. Think of organizations that have lost millions of money just because one individual misplaced a comma or incorrectly typed a figure to a certain cell or row. At the same time, it is worth knowing that technology alone is not the answer. Getting the processes and data right is a critical first step. Thus to obtain the necessary benefits, alignment of both processes and data with technology is key to avoid the risks of automating a broken process that uses unreliable data.
Then there is the issue of “sandbagging” the forecast to protect bonuses. Costs are a bit overstated and revenues a bit understated. If performance is rewarded mainly on the basis of hitting financial targets, managers are more likely to deliberately become conservative in their estimates. Such behaviour should not be encouraged. Sandbagging and gaming interferes with good decision-making. Although such managers appear heroic in the eyes of their peers, it means that important decisions such as resource allocations and investment choices are being made on the basis of inaccurate or incomplete information. Thus to make better decisions, senior executives need to instill a culture where reliable forecasting is encouraged and rewarded. They should demand honest forecasts regardless they like or don’t like what they see. Additionally, incentives must be aligned to relative performance rather than targets.
As the business environment increasingly becomes dynamic and turbulent, managers and senior executives need to review the forecasting capabilities of their organizations and implement reliable rolling and driver-based forecasting. Without reliable forecasting, key opportunities and risks are likely to be missed. On the contrary, reliable forecasts enable the organization to become sensitive and responsive to business conditions and make appropriate changes in real time. They can improve the effectiveness of monitoring by recognizing the context of changing circumstances as these occur. This in turn assists managers to make bold decisions with greater confidence despite whichever direction the market moves.