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.

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CFOs as Masters of Change

The role of the CFO is continuously evolving and so are the demands placed on finance leaders. This is according to results shared by McKinsey from their recent survey.

Here are the key points from Mastering change: The new CFO mandate:

  • CFOs are increasingly playing a pivotal role determining how their businesses adapt to myriad changes and transform the way work gets done.
  • Across the entire finance function, digital adoption is on the rise – especially the use of robotics and AI tools, advanced analytics, and real-time dashboards for key measures of business performance.
  • Almost 60% of respondents reported either a positive or very positive ROI from IT and digital investments made in the past year.
  • Increasing technology adoption in finance could have lasting effects on a company’s overall resilience.
  • Despite digital technology’s promise, high up-front costs, a lack of skills or capabilities needed to build and implement the technologies, and cultural and organizational resistance to changing existing processes are the most common obstacles to adopting new technologies.
  • CFOs have a meaningful role to play in their companies’ ESG programs—especially now, as investor interest in these issues has increased dramatically during the pandemic.
  • CFOs are uniquely qualified to drive changes in how their companies experiment with new technologies, evaluate ESG risks and opportunities, and execute transformations.

While the survey results confirm the ever-changing demands on finance, I have a somewhat different view. Mastering change is not the new CFO mandate. For years, finance leaders have significantly been involved in driving organizational change and transformation.

The COVID-19 pandemic is not the only turbulent change CFOs have had to deal with. In the past, they have played an integral role leading their companies navigate through financial crises, economic recessions, and business restructuring.

Additionally, CFOs are heavily involved in the adoption of new financial reporting and regulatory standards (for example IFRS and SOX compliance) besides new systems implementation and integration.

It is a fact there is increased scrutiny on environmental, social and governance (ESG) metrics from investors, regulators, and the public hence ESG is gaining rigor. Should CFOs take the back seat on these issues? No.

Finance leaders are already the owners of company performance reporting therefore are uniquely positioned to embed new reporting metrics across the company that demonstrate their business practices are more sustainable, more socially responsible, and ethical.

It’s encouraging to see that investments in IT and digital technologies are not going down the drain. For those CFOs still deciding where to start, McKinsey recommends looking at those activities where increased use of digital technologies would add the most value. For example, cashflow forecasting and scenario analysis.

Additionally, I suggest looking beyond narrow adoption and taking a holistic and integrated approach to ensure seamless integration with the greater potential of unlocking value.

With the future of work leaning more towards a hybrid model, the right technology investments will help tackle any product and service delivery challenges for your business and become a source of innovation, competitive advantage, growth, and resilience.

Overall, I highly recommend reading the survey report.

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Finance Transformation is More Than One-Shot Improvement Efforts

It is eighteen months since Max Brown was appointed Head of Finance Transformation of CG Logistics to lead the redesign of the company’s finance function, optimization of finance end-to-end processes, and ultimately drive finance effectiveness company wide.

Prior to being promoted to this newly created role, Max was the Senior Finance Manager – Automobile Division overseeing all aspects of the division’s financial administration, revenue analysis and cost management, budgeting and forecasting, and the preparation of quarterly and annual financial statements.

Given his solid finance experience, significant successes in the past, familiarity with the organization’s structure and culture, and their productive working relationship for the past five years, Debbie Skins, CFO of CG Logistics, was easily convinced that Max was the right candidate to lead the company’s finance transformation agenda.

For Max, this was a big opportunity to bring about the required transformational changes, add value to the business, cement his credibility, and rise in the organization. Unfortunately, since his appointment, not much has changed within the finance function other than the addition of a new cloud-based FP&A system.

Team members are still spending more time on transactional processes versus analytical work and business support. Finance processes are still heavily manual. The function is still replete with non-standard and ad hoc reporting. Management reporting, which most of the time is delivered late, is mainly focused on what happened versus why it happened, how, and what could happen in the future.

Even though Debbie and Max meet regularly to discuss expectations and progress, she is concerned that despite repeated promises from him to course-correct plus her offering him plenty opportunities to redeem himself by form of results, the gap between actual versus desired results continues to widen.

After being in denial for a while, she has finally accepted the fact that Max is not the right candidate to continue in this role. “If the desired results are to be achieved sooner rather than later, we have to take immediate action and replace Max with the right candidate experienced in delivering finance transformation,” she has raised her concerns to Andrew Wilsons, the CEO of CG Logistics who gives her the go ahead to deliver the damning news to Max.

Considering his outstanding record, intelligence, focus, and determination, being let go for not producing the expected results has become Max ‘s worst career nightmare. Never in his career lifetime has he ever been fired for underperformance. In fact, he was head hunted for his first role with CG Logistics.

Instead of wallowing in self pity, play the blame game, and allow this temporary setback to detour his career ambitions, he chooses to learn from this recent setback and not allow his past successes act as a learning stumbling block.

He recalls the wise words of Tim (his mentor), “At some point in your career, you’re definitely going to receive heavy blows and get knocked down but what matters most is how you respond and forge ahead. Don’t be scared or become a know-it-all person. Rather keep your integrity and professionalism in check at all times and embrace a continuous learning and improvement attitude.”

Feeling a bit overwhelmed, he calls Tim. “We need to urgently meet and talk” Max says very directly. “Is everything okay?” Tim asked with a concerned tone. “No, I have just been fired” Max says sternly. “Let’s meet tomorrow at our usual coffee shop, same time” Tim responds.

Always time conscious, Max arrives at the coffee shop fifteen minutes early ahead of the scheduled time, somewhat looking defeated, and sits down like a punctured tire. Only him can attest what was going through his mind at that point. Within a few minutes, Tim arrives sharply dressed in a sky-blue, slim-fit suit and straight-ironed white cotton shirt.

“As you are aware, I was promoted to lead the finance transformation agenda for my previous company. I implemented a new financial planning and analysis tool and even reduced headcount, but this wasn’t enough in the eyes of my bosses. Now they have let me go for underperformance.” Max narrated to Tim.

“I’m sorry Max, we will get to the bottom of this and help you get up and running again.”  First, did you understand what the company is trying to achieve and how your role fitted in?” Tim politely asked.

“Yes, Debbie explained to me what the transformation agenda was. We had periodic performance check-ins. Also, she regularly shared with me feedback from business partners or concerns raised during SMT meetings regarding finance function performance.” Max went on and shared more details.

Looking deep in thought, Tim asked another question “Apart from meeting with your boss including what you’ve already told me, what else did you do?” “You see Max, understanding current reality is very critical. You need to be involved. From the information you have shared so far, I gather you had limited understanding of what the role entails, and rarely met with your stakeholders to discuss and understand their challenges and opportunities.”

Max’s eyes and ears suddenly became intently focused on Tim. “This lack of understanding of the organization’s current reality, unfortunately, caused you to implement quick, superficial solutions that failed to deliver the transformation agenda.” “You are not the first one to fall into this trap.” Tim added. “Finance transformation is a way of thinking. It is a journey that is never-ending.”

“You mentioned you successfully implemented a new system and reduced headcount?” “Yes, I did.” Max responded with a faint voice. “Okay, now tell me what are some of the concerns that were raised by your stakeholders?” Tim further asked. “Well, some complained of untimely reporting while others complained of limited forward-looking insights but more of historical reporting.”

“So then, how did the new system and reduced headcount address these concerns?” Max didn’t answer but slowly nodded as though he had figured something out.

Tim took a deep breath, sipped his favorite iced coffee, and continued the conversation. “Before embarking on the finance transformation journey, as a leader you must be able to determine and tell where the organization is right now.” Max decided to ask a question of his own. “Why is this so important?” Tim sensed that something seemed to be sinking in Max now, so he responded politely.

“This is important for building a roadmap and ensuring appropriate amount of time and resources are devoted to the transformation. Taking time to know and understand current reality helps you assess whether transformation objectives are being met or not, learn from successes and failures, and focus on what matters. Remember, transformation has no end, there will always be a gap between where the finance function is (current state) and where it would like to be (ideal state). Therefore, there will always be opportunities to improve.”

“If only I had received this advice earlier on, I would still have my job today.” Max remarked.  Tim just smiled. “You are going to be fine.” “What else should I have done differently?” Max asked. “Look Max, I am going to be blunt with you on this one. Please don’t be offended. It’s the honest advice anyone is ever going to give you and I’d rather be that one guy in your boxing corner instead of misleading you.”

Seemingly confused with what he had just heard, Max shrugged and half-nodded.

“In your previous roles, you have done very well because of your strong technical skills and incredible attention to detail. These are great tools to have in your toolbox but as for the most recent role, these strengths alone are insufficient.” “Really?” Max seemed surprised. “Tell me about it.”

“Of course.” “Finance transformation is cross-functional requiring input from both internal and external stakeholders on the function’s performance and how it can improve. Thus, each transformation leader must be able to collaborate across the organization and create change instead of maintaining the status quo.”

Max interrupted. “Oh, I get it now. An effective leader changes things, moves them forward, and produces different results than those previously achieved. They don’t do it alone but surround themselves with capable team members. Now I understand why earlier on you mentioned functional expertise alone is not enough.

“Go ahead,” Tim encouraged him. “As I’m reflecting now, I’m starting to notice how I failed to make the leap from being a strong functional performer to taking on the cross-functional role. I focused more on technicalities and kept doing what I was accustomed to. By sticking with the past and not fully embracing my new role, I blew a big opportunity to shine. Surely, it’s time to add business knowledge, strong leadership, communication, collaboration, and influencing skills to my tools kit.”

All this time Max was talking, Tim couldn’t stop nodding in agreement. He shifted in his chair and leaned forward. “Listen Max, I’m glad our meeting has been fruitful, now you get it. I have no doubt in mind you are definitely going to bounce back stronger.” Max felt Tim’s approval and calmly responded. “Thank you Sir.” At this point he looked more relaxed and victorious than he was an hour or so ago when he arrived at the coffee shop.

“Sure, that brings us to the last point of our discussion.” “Finance Transformation is more than simply implementing new systems. Earlier on, you mentioned the various industry events you attended soon after your promotion. One that you spoke a bit more about is Finance Reimagined which you highlighted is one of the biggest annual conferences for Finance professionals bringing together thousands of peers, specialists, banks, technology suppliers, platforms,   CFOs, and thought leaders.”

Tim paused, took a deep breath, looked at his watch, and leaned back in his seat. “Just like you, I enjoy attending such events as they present an opportunity to learn more about best practices, new technologies, and emerging risks and opportunities. However, sometimes I get the sense that some of these events are more about tech companies promoting their new shiny tools and less about learning.”

As a result, leaders end up instantaneously making critical investment decisions from simply witnessing a demo.” Max nodded and asked his final question for the day. “So, if finance transformation is not about technology alone, what then are the other critical success factors?”

Tim smiled before responding. “After seeing countless demos of different FP&A tools at Finance Reimagined, suddenly, you were fully convinced that a specialized planning and BI tool was the key transformation ingredient missing at your company hence the quick deployment. Although technology is a key enabler of efficiencies, it is only one piece of the puzzle. People, processes, and the organization are equally important ingredients.”

Max thought about it for a few seconds, then allowed Tim to continue. “You need the right people with the right skills to use the new technology. If the process is broken and not fixed, no shiny piece of technology can fix that. If the organization or culture is not aligned to what the company is trying to achieve (understanding of purpose), technology alone will not bring about the desired results. Beliefs drive behaviors, behaviors drive actions, and actions produce results.”

Tim paused, but only for a moment to let Max digest the message.

“That’s it for today. Always remember finance transformation is about continuing on a never-ending path towards improvement and not a series of one-time improvement efforts or projects. Mistakes are bound to happen and when they do occur, reflect, learn, unlearn, and continue the journey.”

And so, the meeting ends. Max firmly shakes Tim’s hand and thanks him for his mentorship. As the two men part ways heading in different directions, Max’s confidence was rejuvenated, prepared to face the next challenge.

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Lack of Strategy as a Key Barrier to Finance Transformation

As the custodian of enterprise performance, finance is increasingly expected to add real value to the business and influence better decision-making across the enterprise.

That is, move finance from a pure reporting role towards more forward-looking analysis, decision support, and greater responsibility for managing the overall performance of the business.

In Creating a Value-Adding Finance Function, I highlighted some of the common reasons why many finance transformation initiatives fail. Lack of strategy is one of the key barriers to effective finance transformation.

Strategy is about making specific choices on how the organization will move forward and taking the appropriate course of action to achieve enterprise objectives.

Applied to finance transformation, it’s about identifying and making coordinated and integrated choices to optimize your finance structure, processes, people, and infrastructure.

Finance leaders are contending with a host of challenges including but not limited to:

  • Legacy or overly complex systems and infrastructures.
  • Disconnected data sets and data quality errors.
  • Entrenched organizational thinking.
  • Late financial close, consolidation, and reporting.
  • Manual operations, duplicate work, or rework.
  • Reducing time spent on core transaction processing.
  • Growing finance and operations alignment gap.

Addressing these and other issues is not an overnight process considering the resources required to do so. Unfortunately, many finance leaders attempt to resolve all these problems at once resulting in poor results.

Because of poor planning, they don’t have a defined scope to recognize the challenge and a clear roadmap that focuses resources and actions on overcoming those difficulties. Having and trying to balance too many competing priorities is a sign you are not clear what your strategic focus is actually is.

It’s important to ensure the transformation is aligned with the organization’s overarching strategy and demonstrate how it will help the business achieve its stated objectives.

For the transformation to be successful and effective:

  • First focus on why you are embarking on this journey then how transformation will be achieved and measured. This involves identifying and defining key finance challenges, building an inventory list of those issues to be addressed, and sequencing the inventory based on potential impact and immediacy.
  • Communicate the vision. Don’t transform in isolation, the transformation must be broad enough. Considering the need to close the alignment gap between finance and operations, assess where the function is now, and work with the wider business to create a vision of where it will be in the future.
  • Engage the team or employees, help them understand the benefits and communicate how specific tasks and responsibilities will change. This is key to securing employee buy-in and proactively dealing with any entrenched organizational thinking or cultural resistance.
  • Make clear the skills that will be required in the new finance organization and how the organization will help employees develop the needed skills. Don’t assume that current employees already possess the skills required to perform in the future roles.
  • Implement the how part of your transformation and solicit feedback from the business including employees on how the transformation vision is being executed against expectations. Continually realign your finance organization and adapt your strategy.

Because of competing priorities, it’s absolutely about defining priorities, prioritization and cost allocation, and value for money. Technology alone is not the answer.

Don’t fall into the trap of focusing all your efforts on implementation without considering all the necessary organizational changes required to benefit from the possibilities the new technology offer.

The acquisition and deployment of new technology is not a replacement for strong transformation strategy. Technology is secondary to the strategy it enables.

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