simplified forecasting masterclass cpa australia congress 2016 udpate

Simplified Forecasting Masterclass

Warm up exercise

InstructionsThere are ten questions. You choose a range so that you are 90% confident you have the answer inside your range. Write down the question number, low and high.Some as tables, some as individuals.

Instructions (cont)For example, “Q1: How many plays did Shakespeare write?”

Your answer could look like this:

Q1: 10 to 20

QUIZ!!! Hidden in separate slide

Now please hand your page to your neighbour

Statistically, there is a 99.9% chance that you got at least 6 correct.

The answers

ConclusionsMost people doing this don’t get as many right as expected.

Humans tend to be overconfident.

So now you’re all extra analytical …

Download Slides(SlideShare)http://goo.gl/tkJWwS

PDF: https://goo.gl/IKNJ3n

IntroductionTim Richardson, CPA, B.A., B.Sc, M. Acct.

My CareerDeveloper at small, innovative IT firm. Large clients.Large European firm acquires small Aus IT firm (to access technology and clients)Now even larger clients, in Asia. → Sydney → Jakarta.Works with Finance Director. Joins Philips, put into Finance talent pool → Singapore → Eindhoven (NL). Controller then Finance Director for retail then manufacturing and sourcing.Back to Australia. Equity raising, CFO of a fairly large international online retailer, then started GrowthPath.

Your CareerAccounting has twice been found to be the most likely profession to be replaced by expert systems (modern learning AI)In one survey, retail checkout was the only job more likely to go. In another, it was call centre staff pushing accounting to #2.

The accountant of the future …

Table IntroductionsPlease appoint a row leaderSurvey your table-mates for their forecast experience and how important it is to their role

Time budget: 6 minutes

Glossary“linear”: an equation of a straight line.sales = 10000 + 56X is linear

Sales = 10000 + 56^1.6 * sqrt(sales_last_year -

fc)^2 is not linear.

Glossary‘Regression’ is finding a formula which explains the shape of data. Called a trend line in spreadsheets.

More advanced methods are not limited to straight lines; they can find non-linear lines, like exponential lines.

“Correlation” scores how close the line is to the data.

Glossary‘sand-bagging’: putting in artificially high costs or low sales, expected to be later ‘thrown overboard’ when needed, as in a hot air balloon.

‘gaming’: manipulating forecasts to reach objectives.

‘sensitivity analysis’: changing an important input (like selling price) to see how it affects the outcome of a forecast.

‘big data’: collections of massive amounts of business data which never makes it to accounting records and used to be invisible.

“A good player plays where the puck is.A great player plays where the puck is going to be”

Wayne Gretzky, ice hockey great.

STRATEGYPoints of differenceCompetitive AdvantageBarriers to entry

Plan, Objectives

OperationsBusiness ControlAre we on track? Corrective action.Are there surprises and opportunities?

Traditional forecast

Influential Forecasting

It’s not just about numbers.

There are people too

True or False?Politics is a sign of a less effective forecast:True or False?

Forecasting and anthropologyForecasting is a numerical process

But it also involves opinion, power, politics and the allocation of resources.

Processes which do not affect resource allocation are not important.

Processes which do affect resource allocation will be challenged.

Changing how you do forecasting can therefore meet resistance.

Forecasting outcomes

How important is this outcome of forecasting:

to accurately predict the future.

Rate your answer from 0 = Not important to 10 = the most important outcome

How important is this outcome of forecasting …

To choose the best future from a forecasted selection of possible futures

How important is this outcome of forecasting …

To understand how to influence the future by understanding the link between decisions made today and future outcomes

Now ...Now that you’ve seen all three questions, do you change your first two scores?

Are there other questions to add?

Our objective todaySomething simple: why?

Something relevant to managementSomething useful for decisions: why?

Why is simplicity so valuable?Easier to understand. When someone else can understand your forecast and own it to convince others of the right course of action, you have communicated effectively.

Faster to prepareMore time for other things

When is a number useful to management?

Forecasting through the ages ….We need a definition of forecasting that excludes things like:● tea leaves● tarot cards● chicken entrails● signs from god

Why do we reject these methods today?

Why did people do them anyway?

The use of predictionCenturies of evidence that humans find obviously inaccurate forecasts useful anyway.

It’s very interesting to think about why this is the case.

Problem with stone-age forecastslack cause and effect.They make predictions, but don’t show how we change affect the future.

There is no diagnostic feedback. If the forecast was wrong, why?

A good forecast methodWrite three to five characteristics of a good forecast processTry to include organisational aspects about the process (who, how long, how is it discussed) not just technical aspects.

What trade-offs must you make when choosing a forecast process? A perfect forecast would take one second and be 100% accurate. But in reality, what compromises do you make?

And for bonus points….Sensitivity analysis / multiple scenariosbased on cashflows with a clear separation of

relevant and sunk costs

DECISION FOCUS: Helps focus on what decisions, impacts and opportunity cost (tradeoffs)

CAUSE AND EFFECT: Shows how decisions will affect the future

SIMPLE: People get it, own it, use it.

FEEDBACK: if the future surprises us, our forecast should be diagnostic: what happened, in a way we can action.

CASHFLOW:Very useful to forecast on the cash effects of decisions.

Possible answers: A good forecast …

Predicting the futureApart from tea leaves, how can we make predictions about the future?What is the traditional method of forecasting?

Traditional forecastingTraditional forecasting believes the secret to the future is based in the past.

Often there is a lot of data. The temptation is to believe that the answer is there, if only we apply more and more ‘power’.Statistical forecasting (linear regression, non-linear,... neural networks) is based on discovering trends and patterns in history to tell us what will happen. This is a very common myth (e.g. Asimov’s Foundation books).

These methods can become so complex and powerful they approach a priesthood. Most managers won’t understand them.

Advanced tea leavesTraditional forecasting can be “enhanced” with advanced methods to mine historical data for patterns which will repeat in the future.

But this is, in my opinion, largely a waste of time. This is advanced tea leaves.

Random quizIf my sales are normally distributed, how much of the time will my sales be below two standard deviations from the mean?Write down the answer. You have 10 seconds.

Simplification though focus and aggregation

Historical DataJan 2010 Feb 2010 Mar 2010 Apr 2010 May 2010 Jun 2010 Jul 2010 Aug 2010 Sep 2010 Oct 2010 Nov 2010 Dec 2010

1 2 3 4 5 6 7 8 9 10 11 12Sales $127,843 $188,151 $244,650 $233,176 $281,558 $321,796 $185,085 $257,522 $317,497 $356,247 $345,265 $213,637Cont Margin $51,419 $75,317 $97,433 $92,728 $113,265 $130,243 $73,400 $102,840 $127,327 $142,239 $139,073 $85,928CM% 40.2% 40.0% 39.8% 39.8% 40.2% 40.5% 39.7% 39.9% 40.1% 39.9% 40.3% 40.2%

OverheadsWagebill $22,573 $22,711 $23,198 $22,915 $23,692 $23,830 $23,371 $25,012 $22,320 $22,408 $24,792 $22,597Marketing $10,674 $10,008 $9,905 $10,070 $10,766 $10,493 $10,135 $10,536 $10,450 $10,094 $10,839 $10,226Occupancy $20,065 $19,280 $19,739 $20,784 $20,670 $20,480 $20,926 $20,790 $20,406 $21,495 $20,785 $20,580Insurance $2,076 $2,076 $2,076 $2,076 $2,076 $2,076 $2,076 $2,076 $2,076 $2,076 $2,076 $2,076Interest $2,595 $2,595 $2,595 $2,595 $2,595 $2,595 $2,595 $2,595 $2,595 $2,595 $2,595 $2,595Depreciation $12,974 $12,974 $12,974 $12,974 $12,974 $12,974 $12,974 $12,974 $12,974 $12,974 $12,974 $12,974Overheads $70,958 $69,644 $70,486 $71,414 $72,773 $72,448 $72,076 $73,983 $70,820 $71,642 $74,060 $71,048Profit before Tax -$19,539 $5,672 $26,946 $21,314 $40,492 $57,796 $1,324 $28,857 $56,507 $70,597 $65,014 $14,880

-15.28% 3.01% 11.01% 9.14% 14.38% 17.96% 0.72% 11.21% 17.80% 19.82% 18.83% 6.97%

Seasonality.Linear trend shownHow good is the correlation?

At what time scale does seasonality become more important than trend?

The correlation is poor, but it the trend still valuable?

Statistics (sales)Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Seasonality 2010 4.4% 5.8% 8.4% 8.7% 9.4% 10.2% 5.5% 8.3% 10.5% 11.5% 10.6% 6.9%

Seasonality 2011 4.4% 5.9% 8.7% 8.4% 9.2% 9.7% 6.0% 8.7% 10.4% 11.5% 10.1% 7.2%

Seasonality 2012 4.4% 6.1% 8.7% 8.6% 9.2% 10.0% 5.8% 8.6% 10.6% 11.0% 10.7% 6.3%

Avg 4.4% 5.9% 8.6% 8.5% 9.3% 10.0% 5.8% 8.5% 10.5% 11.3% 10.5% 6.8%

Year on Year Sales Growth Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec TOTAL2011/2010 2.7% 3.4% 5.6% -1.1% 0.4% -2.4% 11.4% 6.8% 0.8% 3.0% -2.7% 6.4% 2.3%2012/2011 2.6% 8.65% 4.65% 6.79% 4.41% 7.56% 0.32% 2.89% 6.98% -0.76% 11.20% -8.34% 2.2%

Statistics: ProfitYear on Year Profit Growth Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec TOTAL2011/2010 4.9% 16.4% 10.6% -10.5% -5.4% -14.0% -138.4% 19.0% 1.5% 2.3% -12.4% 36.8% 0.5%2012/2011 -2.5% 215.7% 8.3% 18.5% 7.7% 19.3% -130.4% 0.7% 13.2% -4.5% 24.6% -50.8% 8.2%

Profit as % sales Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec TOTAL

2010 -12.2% 0.9% 12.7% 13.1% 14.8% 16.6% -2.7% 10.8% 17.8% 19.6% 17.2% 6.4% 11.9%2011 -12.48% 0.99% 13.26% 11.82% 13.90% 14.64% 0.92% 12.06% 17.88% 19.50% 15.45% 8.20% 11.7%2012 -11.86% 2.88% 13.72% 13.11% 14.34% 16.23% -0.28% 11.80% 18.91% 18.77% 17.31% 4.40% 12.1%

CM Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec TOTAL2010 40.0% 39.9% 40.0% 39.8% 39.9% 39.8% 39.8% 39.8% 39.7% 39.9% 39.9% 39.9% 39.9%2011 39.9% 40.0% 40.1% 39.7% 39.9% 39.5% 39.9% 39.8% 39.8% 39.8% 39.8% 39.9% 39.8%2012 40.3% 39.6% 40.0% 39.8% 39.8% 39.9% 39.5% 39.4% 39.9% 39.7% 39.7% 39.8% 39.8%

Which is easier to forecast accuratelyProfit in a specific monthProfit in a specific quarter

What we can we improve so far?Variations month to month are hard to forecast from historical data but the variations smooth out when you aggregate.

We call this “swings and roundabouts”

Mathematically, it’s related to ‘regression to the mean’

First steps: A simplified forecastWe first just take the existing historical P&L data and see where common sense leads us

Based on the data we have so far, What drives the result?

Use a simple annual growth for sale trend.Use last year averages for overhead costsUse avg for GM

Jan Feb Mar Q2 Q3 Q4 TOTAL Actual 2013trend 2.20% Sales $147,178 $205,889 $293,025 $938,101 $841,460 $960,699 $3,386,352 $3,410,359

avg 39.80% GM% 39.8% 39.8% 39.8% 39.8% 39.8% 39.8%

Margin $58,577 $81,944 $116,624 $373,364 $334,901 $382,358 $1,347,768 $1,359,649

avg OverheadsFixed $24,771 Wagebill $24,771 $24,771 $24,771 $74,313 $74,313 $74,313 $297,253 $306,171

Fixed $11,312 Marketing $11,312 $11,312 $11,312 $33,937 $33,937 $33,937 $135,747 $139,820

Fixed $22,153 Occupancy $22,153 $22,153 $22,153 $66,458 $66,458 $66,458 $265,831 $273,806

Fixed $2,087 Insurance $2,087 $2,087 $2,087 $6,261 $6,261 $6,261 $25,046 $25,046

Fixed $2,609 Interest $2,609 $2,609 $2,609 $7,827 $7,827 $7,827 $31,307 $31,307

Fixed $13,045 Depreciation $13,045 $13,045 $13,045 $39,134 $39,134 $39,134 $156,536 $156,536

Profit -$17,400 $5,967 $40,647 $145,434 $106,971 $154,428 $436,048

Actual -$22,888 $6,378 $41,309 $144,049 $111,468 $146,648 $426,964

SummaryFocus on what matters, Take advantage of swings and roundabouts:• Aggregate• Forecast by quarters instead of months (take

a page from the Rolling Forecasting book)

Was that over-simple?We do some some analysis on what’s going on in sales.We are concerned about the role of price and mix play. Maybe growth based on volume increase is too crude?What are some scenarios where this may be the case?

Synthesised KPIsThis business sells a range of products in four categories with consistent margins. There is seasonality and some underlying trend growth.

Synthesised KPIsA synthesised KPI is an indicator created form data you already have. Accounting ratios like days sales outstanding, or inventory stock cover, are examples.

We will explore a measure of sale mix.

Sales KPIs: An example of a synthesised KPI

Price effectMix effectVoume effect

A small technique that may help give some insight into sales trends of product categories

When may it be useful?If innovation or competition is affecting products differentlyThe concept can be extended to anywhere there is ‘something going on’ at a level of detail which is partially or substantially influenced by outside factors

2009 2010 2011 2012 2013Sales $21,135,799 $19,381,347 $21,006,389 $22,907,390 $19,363,575CM $7,001,739 $6,268,051 $6,925,696 $7,554,288 $5,551,022CM% 33% 32% 33% 33% 28%

YOY Sales -7% 9% 7% -24%YOY Margin -10% 11% 7% -36%

Introduction to Sleepy Pty Ltd

Minor spreadsheet pointTo multiply one block of numbers by another, can use SUMPRODUCT(block1, block2)A block from f1 to f5 is written F1:F5

2011 2012PRODUCT GROUPS Qty Avg Price Sales Qty Avg Price SalesCategory 0 32824 $107 $3,512,230 21474 $109 $2,342,974Category 1 21474 $161 $3,446,639 27037 $163 $4,417,849Category 2 32256 $211 $6,814,688 30409 $218 $6,628,260Category 3 28602 $263 $7,513,273 34483 $270 $9,302,344TOTAL 115156 $185 $21,286,830 113403 $200 $22,691,427

Total sales value increase is $1,404,597which is growth of 6.6% we will explore how the change in

sales is due to changes in quantity sold, price, and mix

C D E F G H

SIMPLE PRICE AND MIX EFFECT2011 2012

PRODUCT GROUPS Qty Avg Price Sales Qty Avg Price Sales5 Category 0 32824 $107 $3,512,230 21639 $109 $2,360,8336 Category 1 21474 $161 $3,446,639 27247 $163 $4,452,9147 Category 2 32256 $211 $6,814,688 30741 $218 $6,699,0948 Category 3 28602 $263 $7,513,273 34822 $270 $9,394,549

TOTAL 115156 $185 $21,286,830 114449 $200 $22,907,390

Total sales value increase is $1,620,560which is growth of 7.6%

Price effect

if only the quantity changed, sales would have been $22,346,677

(new qty * old prices) = SUMPRODUCT(F5:F8,D5:D8)

which is growth of ... 2.5%(new qty * new prices) / (new qty * old prices) -1

Quantity effectIf we sold an average product (no mix)...

Due to quantity -0.6% Change in Qty =F10/C10-1

Mix effect

The remaining change explained 5.7%

2012 2013PRODUCT GROUPS Qty Avg Price Sales Qty Avg Price SalesCategory 0 21639 $109 $2,360,833 28616 $111 $3,188,955Category 1 27247 $163 $4,452,914 55583 $168 $9,347,540Category 2 30741 $218 $6,699,094 23021 $225 $5,175,647Category 3 34822 $270 $9,394,549 5912 $279 $1,651,433TOTAL 114449 $200 $22,907,390 113132 $171 $19,363,575Total sales value increase is

which is change of %

Price effect

if only the quantity changed, sales would have been

(new qty * old prices) = SUMPRODUCT(F5:F8,D5:D8) ie new qty * old price, per line

This means price explains a change of

(new qty * new prices) / (new qty * old prices) -1

TIP! New qty * new prices is 2013 Sales

Mix effectThe remaining change explained 66

C D E F G H

2012 2013PRODUCT GROUPS Qty Avg Price Sales Qty Avg Price SalesCategory 0 21639 $109 $2,360,833 28616 $111 $3,188,955Category 1 27247 $163 $4,452,914 55583 $168 $9,347,540Category 2 30741 $218 $6,699,094 23021 $225 $5,175,647Category 3 34822 $270 $9,394,549 5912 $279 $1,651,433TOTAL 114449 $200 $22,907,390 113132 $171 $19,363,575Total sales value increase is -$3,543,815

which is change of -15.5%

Price effectif only the quantity changed, sales would have been $18,793,991

(new qty * old prices) = SUMPRODUCT(F5:F8,D5:D8)

This means price explains a change of 3.0%

(new qty * new prices) / (new qty * old prices) -1

TIP! New qty * new prices is col H

Mix effectThe remaining change explained -17.4%

2012 2013PRODUCT GROUPS Qty Avg Margin CM Qty Avg Margin CMCategory 0 21639 $39 $852,302 28616 $40 $1,139,776Category 1 27247 $38 $1,030,982 55583 $39 $2,177,463Category 2 30741 $67 $2,059,618 23021 $70 $1,601,269Category 3 34822 $104 $3,611,386 5912 $107 $632,514TOTAL 114449 $66 $7,554,288 113132 $49 $5,551,022Total margin value increase is -$2,003,266

which is change of -26.5%

Margin per product effect

if only the quantity changed, margin would have been $5,385,795

(new qty * old CM) = SUMPRODUCT(F5:F8,D5:D8)

This means margin per prod explains a change of 3.1%

(new qty * new CM) / (new qty * old CM) -1

Mix effectThe remaining change explained -28.4%

If price erosion and mix changes are important developments:

new sales = (old_sales*price_effect% + old_sales*mix_effect% + old_sales*qty_effect%)

Note: this is only an approximation and when the effects start getting > 10% more accurate approaches should be considered.

http://www.growthpath.com.au/index.php/Business-Growth/separating-price-and-mix-in-changes-to-sales-and-margin.html

Applying these effects

How to use Price and mix effect are good KPIs for sales and marketing. Influencing price, mix and units sold take different steps. These measurements may capture performance and trade-offs.

Easy to measure. Meaningful. Data is based on invoices so it is already available with little investment in new systems or integration.

Can give effective early warning of trends.

For forecasting:new sales = old sales + old_sales * price_effect + old_sales*qty_effect + old_sales*mix_effect

For business cases: using with margins not price can justify marketing spend based on mix improvements

Synthesised KPIsSynthesised KPIs can’t reveal new information, but they can reveal new perspectives in facts you already have.Since we have lots of accounting data points, this is best place to look for them. Traditional accounting ratios are synthesised KPIs.

Next topic:Making the forecast influential

Making the forecast influentialTraditional forecasting aims to predict future accounting reports mostly using old accounting reports, and the outcome of forecasting is a P&L

But the decisions and the plans for the business are probably focused on customers and innovations.

STRATEGYPoints of differenceCompetitive AdvantageBarriers to entry

Plan, Objectives

OperationsBusiness ControlAre we on track? Corrective action.Are there surprises and opportunities?

Traditional forecast

Influential forecasting

Influence and DiagnoseThe important decisions for a business are mostly based on

Customers, Competitors, Innovation.

So the closer finance gets to that, the more useful we become. Too often finance is merely helping to manage the consequences of those decisions.

But we also need ...Simplicity NumbersFocus

A solution1. Use models but use them properly2. Base the forecast on “business drivers”

What is the default model of traditional forecasting?

Models are great. Are they perfect?Models work because they let us freeze most real world complexity and focus on what matters.If the stuff we freeze is just noise, this is very helpful.

When models go bad1. Black Swans2. When the “noise” actually becomes

important. E.g. you may ignore a stable cost but if it

turns out to be currency driven (supplier offshored) and the AUD crashes...

When models go bad3. When business drivers change (competitor, M&A, innovation, market shift, new management)

Black SwansSo named after the Australian Black Swan.Other examples:

GFCRise of iPhoneSept 11

Black Swans• "Black swans" are highly consequential but unlikely events that are easily explainable – but only in retrospect. • Black swans have shaped the history of technology, science, business and culture. • As the world gets more connected, black swans are becoming more consequential.

Black Swans

• The human mind is subject to numerous blind spots, illusions and biases. • One of the most pernicious biases is misusing standard statistical tools • Expert advice is often useless and overvalued.

Black Swans• Most forecasting is pseudoscience. • You can retrain yourself to overcome your cognitive biases and to appreciate randomness. But it's not easy.

My Black SwansIndonesia 96/97Sept 11, 2001Rise of China 2000sEU Anti-dumpingShift to consumer for CFLiCO2 abatement programsGFC 2009

One of the biggest black swansNorth American shale oil (fracking)Remember peak oil?Now, oil is $50 a barrel and the US no longer needs to import. It has so much gas that cheap energy is now a competitive advantage.

How to deal with black swans?Don’t be over-confident in your forecasts.Be robust and highly responsive to opportunities. We should value forecasting approaches which can quickly adapt to new circumstance. An agile, responsive business will use simple forecasting methods, but simple forecasting methods won’t make a business agile. Extremely expensive and sophisticated models are not better. They can be worse because they encourage over-confidence. Google Long-Term Capital Management.

When models get over-extendedA model which loses its simplicity is a half-way place, the worst of both worlds.

One of the worst examples…Until 15th century, Europeans had the earth at the centre of the universe.

Epicycles to explain phases of Venus

The model kept getting more and more complex.

What was the “Black Swan” for models of the solar system?

Coping with the weakness of modelsBe prepared to change models when business focus changes.

As a habit, diagnose both favourable and unfavourable deviations from your forecast.

What to model?

The P&L as a forecast model: Pros and ConsPROS• You are going to do it anyway• Historical data in this format is

CONS• Bad at focus• Says little or nothing about how

the business wins customers• Poor for diagnostics• Extremely limited at decision

support• Very complex (mix of cash and

imaginary numbers, and technical considerations)

• Serves too many masters

Business DriversA business driver is

●Influenceable by the business●Measurable●Linked to sales (or costs) via a simple

formula

Model built on business driversConnect drivers to a cashflow event with linear formulas: cash_event = driver_score * something1 + something2

You can initially guess something1 and something2.Measuring it means you will get more accurate.

The Perfect CustomerA business should have a “perfect customer” in mind.

This customer should recognise herself in the selected handful of business drivers.

Which of these could be business drivers for a mid-sized residential construction business operating in Melbourne’s north?

• National home lending approvals• Number of visitors to our display homes• Number of VCAT modifications and rejections of our plans• Percentage of modifications per job to our standard home designs• Avg percentage of total home project spend we capture• Percentage of clients who take our landscape gardening bundled

service• RBA interest rate settings• Number of days lost to injury on site

Strategic plan says“We target customers looking for fast, simple and cheaper builds”.

Choose two drivers.

Or Strategic plan says“We will capture high value clients by providing a complete, custom approach to the entire family home project including integrating green space with the home design”.

Choose best two.

Account for most, not allA small range of drivers will not capture every variation in the business, but they should capture most.

Recap Business DriversA P&L is a generic report.

But what is the fingerprint, the DNA of a business?

Business Drivers and business DNAThe DNA of a business is its competitive advantage. How it is different from competitors in a way that adds value to customers.

The selection of the top five or ten business drivers reflects how the business plans to build on its competitive advantages.

A testBusiness Drivers should tell an observer what the business is doing, where it wants to go and how it wants to get there.

A P&L + balance sheet is much less clear

Business drivers vs leading indicatorsLeading indicators may include GDP growth or birth rates. But we can’t affect them.

Your forecast model should lead to choices and decisions. So the role of external leading indicators should be limited.

Business drivers and the sales funnel

Business drivers often make a sales funnelSale funnel is often the most important thing to forecast.

A partial real world exampleIn this business, overheads are quite stable over a three year period, except for marketing and to some extent wage-bill. Project spending (e.g. expansion) is excluded.

Contribution margin and spend per visit are also stable.

NoteThese numbers are disguised and distorted to protect client confidentiality, but not in a way that diminished the conclusions

Business driversThis is a high-end consumer business.The management team has a few common KPIs on their bonus, including• New customer acquisition• Repeat rate

Growth has rapidly escalated

Recent marketing spend

# customers is a leading indicator

Active Customers vs MAT SalesCust

Building a simple forecast modelUse management KPIsFocus on the issue at hand: marketing spend

This is a ”disposable model”: how much has sustained marketing spend helped? Should it continue?

In this business:A customer repeats X times per year (X =2)The avg spend is $Y per visit (say Y = $500)There is a relationship between marketing and new customers

Do a simple time shift (cut and paste in Google Sheets)

→ 2 month lag

Linear correlation mkt vs customer (after time shift)

Active patients 4500 + (spend-150000)/300000*400

Simple revenue model

Example, obscured dataBusiness Driver: Marketing spend (monthly avg) [2 month lag] $400,000

Active patients 4833Business Driver: Annual visits (Repeat rate =2) 9667

Monthly visits 806

Business Driver: Spend per visit $500.00

Monthly revenue $403,000

Done!Tools: Google

Sheets

Time: 1.5 hours

Technical forecasting

Example: Excel 2016 Excel 2016 has a new forecasting model which defaults to “AAA version of the Exponential Smoothing (ETS) algorithm”I googled it and came to a PDF with pages that look like this:…

This is 90 slides of explanation for this feature (in R, which I assume Microsoft has ported to Excel 2016 (Windows, not mac))

Technical forecastingTechnical forecasting which uses advanced statistics on historical accounting is looking for hard to see connections in historical data you already have.

But the most important relationships are easy to see

Simple Forecasting and Big DataI will extend meaning of ‘big data’ to include “integrated data”.

This could mean: web stats, social media engagement, detailed job progress data and real time (sales, competitor, location…)

Predictive analytics means finding hidden connections between data and cash-flow events with neural networks and other advanced methods.

This could be very awesome even for SMEs.

Unlike traditional technical forecasting, big data introduces new information to the business.

Predictive analytics (Big data)

Definition (Forrester)“Using patterns discovered in heterogeneous [mixed] sources of data, business analysts and data scientists can create predictive models to improve business outcomes.”

Obviously, this is very interesting to my vision of business forecasting

Keep it Simple• By discovering and ranking business drivers,

predictive analytics can help simple models work better.

• But the value of simplicity is not washed away by neural nets and super-computers.

Examples of simplicity visualised

A sales model based on non-accounting leading-indicator drivers can provide continually refreshed forecasts.

Simple forecasts and open-source technology make this cheap and easy.

Forward drivers can be shown easily

Diagnosis

Communication and analysis

Measures which everyone understands. They get how to influence them. They are bonused on them.

Result: very strong alignment and engagement and everyone is on the same page.

It’s simpleIt’s customer facingIt’s aligned to relevant decisions and focus

Is it diagnostic?

So far, so good.

Growth-driven forecastingSimple forecasts can change fast. We are not committed to long complex processes and heavy IT.

So, let’s take advantage ...

We sit in a discussion about growthWe have done some “predictive analytics”. It shows that customers who buy a more diverse range of products are more likely to be repeat customers.What business drivers does this suggest?

Our aim is to reforecast the business in a few minutes

Come up with a sketch of a new driver and try to include it in a forecast model.

What about cost drivers?Forecasting significant costs is the same.Influenceable, measurable drivers.

Is currency influenceable?

What makes this more than just a basic spreadsheet?

The selection and use of business drivers is the magic sauce. In terms of actually doing it, though, a spreadsheet is completely adequate.<Insert funny SAP R/3 story here>

Finding cost and/or sales drivers...

Follow the points of difference (the competitive advantage) OR management plans.This will reveal where to focus.

A business selling a commodity (iron ore): where are its points of difference?

Using simple forecasting for accountabilityThe forecast should reflect the key decisions through the business and cost drivers in use.

These should then be measured for diagnosis and accountability.

External factors beyond influence?Such as: Currency, economic growth, droughts, Chinese economic collapse …

Two options

1: Be nimble, assume competitors are equally affected. React & forecast when it happens and otherwise ignore.

2. We can’t influence them, but we can include them in the simple forecast for sensitivity analysis

Discussion … Which approach fits best with the “simple forecast” philosophy?

Simple forecast maturity modelLevel 1:Streamline the traditional forecast method. Use drivers or KPIs synthesised from accounting data such as price & mix effect, ratios like debtors days outstanding.

Simple forecast maturity modelLevel 2Use non-accounting business drivers for sales funnel and/or key costs, feed this into traditional forecasting.

Measure actual drivers and diagnose, several times per year but outside of the normal reporting and analysis

Simple forecast maturity modelLevel 3:Business drivers are aligned to strategic plan and incentive schemes. All business drivers meet the definition.They are the central discussion in forecasting and reviewing results. They are used for sensitivity analysis.Dashboard tools provide daily or real-time insight into business drivers and automatically updated forecasts.

Simple forecast maturity modelLevel 4.Business drivers are partly based on predictive analytics. Forecast models are revised to follow changes in management focus or market developments.

ConclusionsSimplified forecasting is part of the new finance function. It brings finance closer to influencing profitable decision-making by aligning with the points of difference which lead to growth.

ConclusionsSimplified forecasting swaps analysis of historical accounting data for a small set outward-looking, predictive measurements

It is diagnostic.It uses simple models, and new models when needed

ConclusionsSkilling up• Understand or suggest a small set of business drivers• The future added value of finance will be around

numerical strengths. Consider CPD on statistics, predictive analytics and decision theory.

Books to read/sites to visit• Black Swan: Impact of the highly improbable (N. N.

Taleb)• Visual Explanations (E. Tufte)• The Emperor’s New Clothes (H. C. Andersen)• Khan Academy: Probability and Statistics (website)• Superforecasting (Tetlock and Gardner)

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