TagFP&A

The Accuracy in your Forecast Matters More than the Forecast Itself

One of the roles of the FP&A function is predicting future business performance and help business leaders prepare for an unplanned future through forecasting and decision support.

Although anticipating the future is challenging given today’s fast-changing environment, looking ahead is increasingly essential.

The world is far, far more complex than we think. Unknown unknowns and known unknowns have replaced the routine, the obvious, and the predicted.

Resultantly, many of the assumptions on which important future business decisions are based are easily refuted with the passage of time. For example, one of the most common outcomes of the typical business planning process is a hockey stick forecast.

These forecasts usually show significant business growth and profitability prospects. The last few years of actual results are flat, and then magically shoot up for future years just like the blade of a hockey stick.

It’s a rare experience to come across a forecast that shows a downward spiral of business performance.

Businesses leaders often present a positive outlook of enterprise performance even if the odds of achieving their bold aspirations are slim. This is emblematic of human’s limited ability to accurately predict the future.

Tunnel vision

In his book The Black Swan, Nassim Taleb demonstrates how humans suffer from the delusion of knowing. We underestimate what the future has in store.

In the same manner, we tend to develop a tunnel vision while looking into the future, making it business as usual, when in fact there is nothing usual about the future.

Instead of acknowledging our unknowledge of the future, we continue to project into the future as if we are experts at it, using tools and methods that exclude rare events or outliers.

Although these rare events are most of the time external to the organization, they play a significant role in influencing the operational and strategic performance of the business.

The problem with many business performance forecasts is that they tend to focus on a single point destination or outcome, including a few well-defined sources of uncertainty ( known knowns) at the expense of others that do not easily come to mind.

The goal is not to predict or forecast all improbable events but rather to have an open mind and acknowledge that the likelihood of your actual future being different to your predicted future is considerably high.

Think of new products that failed to hit the mark with customers, projects that experienced cost overruns or took longer to complete, companies that failed to survive their forecast horizon etc.

The list of forecast horror stories is endless. I am sure in 2003 the thought of Lehman Brothers going under five years later was a laughable idea and outside the company’s projections.

Mitigating the tunnel vision

When it comes to forecasting, most of us adopt the inside view to assess the future performance of the business or any other project.

In other words, we tend to plan and forecast based on the information in front of us, neglecting some sources of uncertainty outside the plan itself. Daniel Kahneman, the well-respected psychologist has termed this WYSIATI – What You See Is All There Is.

As a result, we produce plans and forecasts that are unrealistically close to best-case scenarios. However, there are many ways for any plan to fail, and although most of them are too improbable to be anticipated, the likelihood that something will go wrong is high.

The cure for tunnel vision is taking an outside view of that which is being forecasted. Optimism bias often gets into the way of accurate forecasting leading to some of the horror stories mentioned above.

Thus, to avoid falling victim to optimism bias it’s important that you go through all the statistics of projects or initiatives similar to that being forecasted. This will help you identify an appropriate reference class and use the statistics to generate a baseline prediction which acts as an anchor for further adjustments.

Measure your forecasting error

Even though the world is complex and constantly changing, many planners are still adopting a simple view of the world as evidenced by their click and drag forecasts projecting into the long term future. Simply extrapolating projections from one year into the next is a mistake.

The accuracy of forecasts is more important than the forecast themselves. Do you attach possible error rates to your forecasts and measure the actual error rate after the forecasted horizon has passed? As the projected period lengthens, the larger the cumulative forecasting errors.

Despite evidence of enormous forecasting errors in the past, there is an ingrained tendency in us to ignore failure statistics and believe we are suddenly better at predicting the future compared to our uncomprehending predecessors.

Should we therefore discard predicting the future altogether? No, we first need to acknowledge that what we think we know about the future is not all there is. Our comprehension of the future is limited. From there on we can plan while bearing in mind such limitations.

In other words, we should stop overestimating our known knowledge about the future. We may be good at predicting the ordinary, but not the irregular, and this is where we ultimately fail.

How Effective is Your Budgeting and Forecasting

The only thing right about a forecast is that it’s wrong. This unavoidable truth is particularly evident in business today. Businesses are grappling with high levels of volatility, uncertainty, complexity and ambiguity.

Increasing regulation, competition, geopolitical tensions, ever changing consumer preferences and a shift in economic powers are making it difficult for finance teams to predict business performance with certainty.

Although no forecast is 100% certain, forecasting is not a futile process. Today’s complex and fast paced environment demands agility, flexibility and confident decision making. Making use of dynamic forecasts to support key operational and strategic decisions can help businesses overcome these challenges.

Single Point Destination

Budgeting, planning and forecasting must evolve into something more relevant to today’s operating environment.

Many organizations prepare budgets to estimate single-point future outcomes and allocate resources required to meet specific goals. Although this works well in a stable environment, this is far from true in today’s unstable world.

Emerging risks and opportunities are forcing the business to regularly re-examine its value proposition model and adapt its strategy. At the same time, the resources required to deliver superior performance are highly volatile and unpredictable.

As a result, goals are often becoming moving targets requiring regular monitoring and adjustments.

This raises the need to adopt modern FP&A processes that empower the business to evaluate performance beyond a specific point in time and swiftly respond to external and internal fluctuations.

The annual budget fails to make the business become forward-looking and plan beyond the 12 month period. On the contrary, continuous rolling forecasts help decision makers to:

  1. Focus more on the future rather than on the past
  2. Model future scenarios based on current business drivers
  3. Get insights in terms of where the organization is heading
  4. Highlight significant gaps between expected performance and defined budget targets
  5. Make informed decisions that are reflective of the business operational environment

Basing future decisions on a single point of view in today’s constantly evolving environment is not ideal. Decision makers should consider a range of potential outcomes, to better represent and understand possible scenarios.

Link Risks and Opportunities 

Many budgets that companies are using are prepared from a numbers perspective only.

The norm here is to pull out past financial results, add or deduct a percentage amount to the chart of accounts line items. In most cases the numbers are dependent on inflation, interest, foreign exchange and GDP statistics.

Other performance drivers specific to the business such as category growth, market share, consumer behaviour, supply chain risk, website traffic, conversion rates and production capacity are often not considered.

Take for example the impact of social media today. Social media is increasingly empowering consumers granting them more buying power. Brand and user experiences are shared 24/7 on these platforms.

Brands that are able to align their value delivery models with consumer expectations stand to benefit above peers in terms of reputation and financial rewards.

As social media continues to provide a communication platform for consumers, it is vital that companies factor in social media risks and opportunities into their financial planning and analysis models.

Building new capabilities capable of integrating and interpreting multiple sources of data and business drivers is the first step towards progress.

Complex Spreadsheets Standing in the Way of Progress

To succeed in a hyper-competitive environment, the business must be able to make informed decisions and move on with speed. This requires the company to incorporate a flexible budgeting and forecasting framework that helps it to instantly develop and analyze different scenarios.

A lot of companies are incapable of producing this analysis quickly, mainly because the majority of systems in place are not essentially fit for purpose. Complex spreadsheets only the creator understand are dominant.

Challenges arise when individuals attempt to add additional budget and forecast line items or change formulas and are unable to do so. The file is sent back to the creator for amendments.

This review-revise-redistribute cycle increases data latency and slows down decision making.

Finance should replace complex spreadsheets with new collaborative technologies. This will help streamline and standardize FP&A. Cloud solutions improve collaboration and response times between users, enhance governance and control by reducing version control problems. Also, the likelihood of input errors getting unnoticed is reduced.

Centralizing budgeting and forecasting across the business ensures that inputs to the process follow common standards and classifications. This reduces the need for people to add additional budget and forecast line items, helps track progress across all business areas and enable easy re-forecasting without changing the entire model.

Given this current world of advanced analytics and IoT, machines keep on getting smarter. Leveraging improved computing power, they are now able to aggregate large data sets, identify patterns and correlations and inform predictions within shorter time frames.

Although adoption of emerging technologies is not yet mainstream, the potential for companies to augment human and machine capabilities and shift from reactive to anticipatory driver-based planning is massive.

Budgeting and forecasting transformation is not achievable overnight. Learn from past failures and understand why a prediction went wrong. The idea is not to seek certainty, but rather to influence the future.

Instead of setting the organization on a particular path, Finance should focus on identifying a range of potential outcomes and help decision makers make rational strategic decisions based on the most plausible set of scenarios.

FP&A Leaders are Failing to Deliver Higher Strategic Value

Last month, Prophix Software released its findings from the survey, Defining the Evolution of FP&A: Benchmarks, Challenges & Opportunities. The survey which was carried out between Q2 and Q3 of 2017 received feedback from over 300 FP&A leaders from all companies of all sizes across the globe.

The survey was conducted to establish the maturity of analytics solutions across the globe, the effectiveness and efficiency of FP&A leaders’ planning processes, how companies are leveraging technology to improve FP&A processes, and to gauge internal perceptions relative to the value of FP&A.

Although certain parts of the results are encouraging, FP&A teams significantly need to improve on their role of delivering higher strategic value to their companies.

In today’s fast moving markets, characterized by intense competitive pressures, shorter product life spans, complex business environment, increased volatility, and heightened uncertainty, it is imperative that a company’s FP&A people, processes, and systems are highly mature, effective, efficient, and leverage the necessary enabling technologies.

While going through the survey findings, a couple of statistics captured my attention.

  • 55% of the survey respondents reported being in a basic or developing state of the FP&A analytical maturity.

Comment: Essentially, more than half of the survey respondents have no formal FP&A process, no established analytical and reporting matrixes, no planning model and tools as well as BI tools. If ever they are there, these are all basic, highly manual and descriptive in nature.

This basic level of analytical maturity brings to light the fact that a culture of continuous innovation and improvement is non-existent in Finance. As the custodians of data within the organization, one would assume Finance to be at the forefront of analytical maturity, but this is not the case.

Surprisingly, 50% of respondents are mindful of technology but seldom upgrade. This statistic alone is concerning. Why are FP&A leaders reluctant to change? Are they happy with the status quo? Are they lacking the resources necessary to transform? Is it ignorance in its purest form?

Transitioning from a basic to an advanced or leading FP&A maturity level, above all, requires a cultural shift all the way from the top to the bottom of the organization. There has to be a desire to change for the better, a willingness to commit and continuous learning attitude.

Attending industry conferences, seminars or webinars and reading thought leadership resources as well as listening to their podcasts can help FP&A leaders keep abreast of trends and benchmark their company’s performance against peers.

  • Only 12% of the survey respondents have access to the right data, at the right time, to inform strategic decisions at their companies.

Comment: Having access to the right data, at the right time is key to informing strategic decisions and driving business performance. Unfortunately, 88% of respondents do not have this access.

This means the majority of critical decisions in companies across the globe are based on gut-feel and not evidence-based.

In today’s Big Data age, it’s startling to know that companies are not leveraging advanced analytical tools to aggregate and analyze data from disparate sources and generate key nuggets on customer experiences, competitor behaviour, trends, emerging risks and opportunities.

Moving forward, FP&A leaders need to make use of data management framework that facilitates the creation of a central data repository and ensures everyone in the company has access to relevant data whenever they need it.

This can only happen if the company makes a key decision to advance its analytical maturity model. Highly manual processes make it difficult to update FP&A models in real time, thereby inhibiting quick decision-making processes.

With the recent advancements in technology, the costs of implementing new software to enhance FP&A processes have significantly reduced. Companies should therefore not use cost as an excuse for low adoption rates.

  • Only 10% of companies reported that they find it somewhat easy to perform scenario analysis.

Comment: In today’s VUCA business environment, companies need to be proactive, develop superior forward-looking capabilities and be ready to deal with any disruptive forces threatening their survival and existence.

They need to become more flexible, adaptable and be increasingly aware of the impact on business performance of changes in the environment. This will help them take corrective actions more quickly and efficiently.

Unfortunately, 90% of the surveyed companies are finding it difficult to perform scenario analysis. As already reported, over half of them are still reliant on basic and highly manual processes which in turn makes it difficult to consider all possible scenarios in their FP&A models.

For the 10% who are finding it somewhat easy to perform scenario analysis, what are they doing right? They have managed to figure out that FP&A is a collaborative process extending beyond the walls of Finance. Also, rather than use fixed time-specific budgets, they are using driver-based rolling forecasts to see beyond 12 months.

Instead of sitting on their desks all day long, these professionals engage the wider business community, learn about the external and internal factors influencing strategy execution, how they are all interrelated and their material impact. They are then able to leverage new technologies, calculate any probabilities and update their FP&A models in real time.

Having a deeper understanding of the key drivers of business performance helps FP&A leaders define relevant scenarios that describe a range of future operating environments, and generate forecasts reflecting the changes in scenarios which in turn helps decision makers to adjust their strategic plans, targets and action plans.

  •  55% of respondents conveyed that their companies don’t think that FP&A delivers high strategic value.

Comment: FP&A professionals are a critical part of the Finance team. They help operational and strategic decision makers make informed decisions by providing them with reliable, timely and fact-based recommendations.

They bridge the gap between financial and operational plans and ensure decision makers receive the right information, at the right time. The reason why 55% of the surveyed companies are not happy with value-delivery of FP&A is because FP&A teams are spending the majority of their time on low-hanging fruits.

According to the survey findings, 51% of the time spent on FP&A is allocated to data collection or validation. Thus, instead of spending more time on generating insights and influencing business decisions, FP&A teams are busy reporting on the past and justifying reported results.

This quite understandable given the high levels of technological immaturity in many companies. By leveraging advanced analytical tools, FP&A will be able to reduce time spent on data collection, reconciliation and cleansing and free up resources that can be used to deliver higher strategic value.

Instead of generating reports and analysis that they feel are valuable, FP&A teams should regularly liaise with business teams and establish their reporting and information requirements. This will help ensure that resources and time are constantly not being wasted on non-value adding activities.

For the majority of companies that are still basic or developing their analytical maturity, I recommend that they take a candid review of their current FP&A people, processes and systems, and make an honest conclusion of whether they are happy with where they are at the present moment or need to make significant changes.

Everything might look good today, but always remember that Good is the Enemy of Great!

Data Analytics and the FP&A Function

Technological advancements in Big Data and Analytics are having a significant impact on the business’s operating model and strategic performance. Many companies are already exploring how best they can adopt big data and analytics technologies to improve their businesses,  reduce costs, streamline processes,  improve marketing initiatives, and pursue future profits. In the majority of these organizations,  the marketing function and supply chain are leading the pace in applying these new analytic capabilities and serving the customers. Unfortunately, finance is lagging behind and still holding on to its legacy systems and primitive technologies.

All is not yet lost, there is still hope for finance to embrace advanced analytical technologies and help drive business performance. In addition to helping marketing and supply chain functions, Big Data and Analytics can too play a critical role in supporting the finance function fulfill its FP&A role in today’s dynamic business environment. In a world awash with large volumes of data, unstructured and structured, being able to identify patterns, anomalies and derive strategic insights is key for effective decision making. Having this ability to access, synthesize and monetize data requires the FP&A function to invest in new skills and data tools and take advantage of the potential uses of new data types.

It is therefore imperative for the CFO to consider the implications of investing in Big Data and Analytics technologies as well as the impact of using data for effective decision making. Modern technologies are not the domain for the CIO only but also for the CFO. Finance must learn to partner with the business, understand the language of IT and develop an ability to identify and evaluate the various ways data analytics technology can help the FP&A function. CFOs should be asking themselves, how best can they leverage Big Data and Analytics technology to help improve the organization’s budgeting, planning and forecasting processes? How best can they enrich operational and financial forecasts with the most reliable data and make them more accurate?

While everyone is talking about Big Data and Analytics these days and how they have the potential to transform the organization and create a competitive advantage, it is easier for management and executives to join the “Big Data Dream” without first formulating a clear and coherent data strategy. In the end, these executives end up collecting large volumes of data, most of it being worthless, resulting in the business incurring significant data costs and suffering from ineffective decision making.

The value in data is found when the organization is able to collect, synthesize, analyze and retrieve strategic insights from that piece of data and improve decision-making process. Key to consider prior making significant investment in data analytics technologies is the alignment of data strategy with the broader strategy of the organization, data access and governance issues, new skills requirements, and implementation road map.

One of the challenges facing many FP&A functions is assessing the relevant data to analyze, identifying trends and gaining valuable strategic insights. When preparing forecasts and analyzing business performance, there is need, for example, to synthesize data across operational, financial and customer information. How can all this data be integrated and used for decision support purposes? Unfortunately,  not many finance professionals possess this ability to manage this new data and new data types in a way that creates visibility across the organization and benefit other functions. Thus, it is crucial for the FP&A function in today’s economy to develop data mining and analysis capabilities to ensure relevant data is being used for strategic and performance improvement decision making processes.

There is a need therefore for the organization to radically change its data approach and evaluate how it fits well within the overall strategy of the business. Ensure effective KPIs, measures and metrics are designed and implemented to help managers run the business. This approach will ensure that information requirements as well as investments in advanced technologies are not managed in silos but rather, in a deliberate and organized fashion that aligns and supports the broader strategy of the business. Furthermore, as data becomes a strategic asset to the organization,  it is crucial that the CFO collaborates with other senior executives of the organization and engage them in planning conversations and collaboratively find ways of improving business performance.

In today’s economic environment, data is found everywhere, both internally and externally and this data can only be accessed if finance decides to leave its comfort zone and begin engaging with the business. Unfortunately, many finance professionals have a strong technical background and are weak when it comes to soft skills. Walking around the business, initiating conversations with other functions and asking smart questions doesn’t come naturally to many finance professionals. However, as the role of finance continue to evolve, the finance organization must learn to adapt and acquire new soft skills to avoid being left behind in the back office.

Today’s finance professional is required not only to have data skills, but also the ability  to communicate with the broader organization, have a strategic mindset and a deeper understanding of the operational areas of the organization as well as the ability to identify opportunities and help the business grow by  reducing costs, evaluating and increasing top-line revenues. FP&A must be able to ask smart questions and identify the relevant business needs that can be addressed by data analytics. How can the business benefit from technology, make smarter and faster decisions and also become more efficient? How can an investment in data and analytics technology help the business identify emerging or unknown risks areas and manage these risks intelligently?

By taking advantage of data analytics technologies, the FP&A function will be able to identify business performance leading indicators based on the data available, adjust forecasts and drive that information into operations. Uncertainty and volatility in the global economy  are on the rise and because of this, many business executives are worried and cautious about where to make large capital expenditures. As the support function with a larger visibility across the organization,  the FP&A function can help address this uncertainty.

By embracing modern technologies, the function can transition from business intelligence and reporting on what happened, to data mining and understanding why something happened, to predictive analytics and determining what is likely to happen and when. This will in-turn help  management and executives put contingency plans in place and become proactive.

Taking a phased approach is necessary when implementing data analytics technologies.  Instead of going full force with the implementation,  the organization can start small and use a specific business unit as the basis for the pilot project. Results from this experimentation can then be used to evaluate technology performance in terms of ease of use, speed and benefits. If the results are satisfactory,  the next business unit or region is selected and the process continues until there is a complete roll-out across the entire organization.

 

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