fine-tuning business plans in the face of persistent ...€¦ · { 1 } forecasting performance...

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Forecasting Performance Fine-Tuning Business Plans in the Face of Persistent Uncertainty

A CFO INSIGHT REPORT

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ForecastingPerformance

Contents

About this Report 3

The Troubled Quest for Growth 4

Predicting the Unpredictable 5

Steps to Better Planning, Budgeting, and Forecasting 7

Working Together to Forecast Effectively 9

Sponsor’s Perspective 10

Forecasting Performance: Fine-Tuning Business Plans in the Face of Persistent Uncertainty is published by CFO Publishing LLC, 51 Sleeper Street, Boston, MA 02210. Please direct inquiries to Matt Surka at (617) 790 3211 or [email protected].

CFO Research developed the hypotheses for this research independently. S A Partners funded the publication of our findings.

At CFO Research, Celina Rogers directed the research, and Matt Surka wrote the report.

December 2012

Copyright © 2012 CFO Publishing LLC, which is solely responsible for its content. All rights reserved. No part of this report may be reproduced, stored in a retrieval system, or transmitted in any form, by any means, without written permission.

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About This ReportIN NOVEMBER 2012, CFO RESEARCH conducted a survey among senior finance execu-tives at U.S. companies to examine their current goals for planning, budgeting, and forecasting—and how they aim to achieve those goals successfully.

We gathered a total of 236 complete survey responses. Respondents work for companies in a broad range of company segments, as follows:

ANNUAL REVENUE

Less than US$100 million 39%US$100 million to US$1 billion 31%US$1 billion or more 30%

TITLES

Chief financial officer 40%Director of finance 17%Controller 16%VP of finance 13%EVP or SVP of finance 5%Finance manager 3%Treasurer 2%CEO, president, or managing director 2%Other senior executive with finance responsibilities 1%Other 1%

Note: Percentages may not total 100%, due to rounding.

Respondents work for companies in nearly every industry. The manufacturing sector (including auto and industrial manufacturing) and the finan-cial-services industry (including real estate and insurance) are particularly well represented.

“A SOLID MAJORITY OF RESPONDENTS SAY THAT IT WILL BE HARDER FOR THEIR COMPANY TO MAINTAIN PROFITABILITY OVER THE NEXT TWO YEARS.

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The Troubled Quest for GrowthCUTTING COSTS IS A SUREFIRE WAY TO boost profitability in a tight economic envi-ronment. But what does a company do when markets still haven’t recovered, input prices con-tinue to crawl upward, and stripping out costs is no longer enough? Find new ways to grow, say finance executives in a recent study conducted by CFO Research.

Companies are putting increasing emphasis on the hunt for growth opportunities, shifting away from the intense focus on cost control that car-ried them through the economic crisis. Compared with the widespread emphasis on cost control that characterized the downturn, recent years have seen a fairly even split between growth-seekers and cost-cutters: In a November 2012 survey of 236 senior finance executives at U.S. companies, 42% of respondents say that over the past two years their companies’ primary business objective was to look for growth. Thirty-nine percent say their companies were still focused on controlling costs during that time.

The trend toward reaching for growth will con-tinue, say finance executives. According to our survey, over the next two years 61% of companies will focus primarily on identifying new growth opportunities, and only 20% will keep their gaze locked on cost-control. (See Figure 1.) For many companies, this continuing shift toward seeking growth is less than voluntary, as most markets have not recovered nearly enough to support unbridled expansion. Instead of ramping up production to keep pace with rising demand, companies are faced with far more challenging work: finding new growth opportunities where

there are few. A solid majority of senior finance executives (69%) say that it will be harder for their companies to maintain their profitability over the next two years (compared with the past two years), suggesting that companies’ renewed focus on seeking growth will not be accompa-nied by an abundance of opportunities. To grow revenues in the face of continuing scarcity, many companies will need to extend themselves into new regions, industries, and markets—all while striving to preserve the efficiencies they achieved during the downturn.

Identifying new growth opportunities

Controlling costs to maintain profitability

n ...over the past two years? n ...over the next two years?

FIGURE 1 Finance executives indicate an increasing focus on the search for new growth opportunities.

Which of the following statements best describes your company’s primary business objective…

Capturing market share from competitors

39%

17%

20%

16%

61%

42%

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Predicting the UnpredictableSUCH HARSH AND RAPIDLY SHIFTING conditions make developing reliable forecasts much more important—and much more chal-lenging. Our research indicates that companies are struggling to forecast effectively. Only 10% of finance executives say that their companies’ actual performance has generally fallen within 2% of forecast over the past three years. (See Table 1.) One-third of companies have experienced between 3% and 5% variation from forecast, and another third have experienced variances between 6% and 10% of forecast. An alarmingly high percentage of companies—24%—have experienced deviations from forecast in excess of 10%.

Asked whether their companies’ forecasts have tended to be mostly conservative, mostly opti-mistic, or evenly distributed between conserva-tism and optimism, our survey results indicate a slight tilt toward conservatism in recent years. According to our survey, 43% of companies’ forecasts have tended to underestimate actual performance, 31% have tended to overestimate actual performance, and 26% have oscillated between underestimating and overestimating performance. The inclination to forecast conser-vatively is to be expected, since finance depart-ments rely on sales and line-of-business manag-ers for much of the data that informs forecasting models—and both groups have a tendency to underestimate performance in order to manage expectations. But the widespread practice of basing forecasts in part on a process of negotia-tion among finance, sales, and operations reduces the credibility of the forecasting process. Where the problem is extreme, forecasting-by-negoti-ation can lead companies to base decisions on

significantly distorted projections—and hence a distorted view of reality. In an environment where finding a growth opportunity or capturing market share means deploying scarce resources toward changing objectives effectively, poor fore-casting can be a death knell over the long term.

Finance executives most often attribute variances between forecasts and actual performance at their companies to a factor outside their control: uncertainty in the external business environment. In our survey, more than half of respondents (52%) say that such uncertainty (e.g., input-price volatility) is one of the greatest contributors to deviations from forecasts. Of course, one of the major objectives of forecasting efforts is to make predictions about an uncertain future with reasonable reliability. But extreme volatility in recent years—particularly volatility in the price of key inputs like fuel and raw materials—have pushed many companies’ forecasting models well

“AN ALARMINGLY HIGH PERCENTAGE OF RESPONDENTS—NEARLY ONE- QUARTER— REPORT THAT ACTUAL PERFORMANCE HAS VARIED MORE THAN 10% FROM FORECAST OVER THE PAST THREE YEARS.

TABLE 1 Survey results indicate that most companies are experiencing variances between forecasts and actual performance in excess of 5%.

Over the past three years, actual performance has generally fallen within…

+/- 2% or less of forecast 10%

+/- 3% to 5% of forecast 33%



+/- 21% or more of forecast 5%

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“IT IS ALL ABOUT DEMAND. THAT HAS BEEN THE MONTHLY MYSTERY OF THE RECENT PAST.”

—CFO, MIDSIZE CONSUMER-GOODS FIRM

Asked to indicate the area in which their com-panies will find it most challenging to forecast over the next two years, more than half of finance executives (53%) say that revenue forecasting will be most difficult. “It is all about the demand,” says the CFO of a midsize consumer packaged goods company. “That has been the monthly mystery of the recent past.” Forecasting projects and busi-ness initiatives follows somewhat distantly, with 35% of survey respondents selecting it as one of the most challenging areas for forecasting.

beyond their historical tolerances. While some of those models have improved with the incorpo-ration of new data, many finance executives are resigned to increased volatility, particularly in input prices and consumer demand. Respondents to our survey estimate that volatility in three major categories—input, demand, and labor—will stay the same, at best, over the next two years. (See Figure 2.) Volatility in input prices and avail-ability is especially likely to increase, according to finance executives. “Market conditions remain volatile and highly competitive,” says the CFO of a large manufacturing company in an open-re-sponse question. “We are not projecting things to get any better.”

FIGURE 2 Finance executives predict mounting volatility over the next two years.

Over the next year, does your company expect volatility in each of the following categories to increase, stay the same, or decrease?

Volatility of input prices and availability

Volatility in demand for our goods/services

Volatility in labor prices and availability

WILL DECREASE WILL DECREASE WILL DECREASE

WILL INCREASE

61%WILL

INCREASE

55%WILL

INCREASE

47%

WILL STAY THE SAME

38%

WILL STAY THE SAME

36%WILL STAY THE SAME

51%

2% 9% 2%

Note: Percentages may not total 100%, due to rounding.

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Steps to Better Planning, Budgeting, and ForecastingWHEN CONSIDERING CHANGES THAT would help their companies realize their plan-ning, budgeting, and forecasting objectives over the next two years, finance executives see the greatest potential in improving processes (through, for example, adopting driver-based planning). A plurality of respondents to our survey (41%) view process improvement as one of the most valuable changes their company could make as part of its efforts to plan, budget, and forecast more effectively—one that merits sub-stantial management attention. One VP of busi-ness planning at a midsize construction company advises, “Establish a senior leader for process improvement, empowered to make changes and hold people accountable.”

Finance executives also endorse business mod-eling and scenario analysis, with the second largest share of respondents—32%—identifying improved modeling (which includes, for example, making better use of what-if analysis) as an espe-cially viable source of improvement in planning, budgeting, and forecasting. Advises the CFO of a large aerospace/defense firm, “Provide as much

historical trend and what-if modeling information as possible, along with range (and probability of outcome with drivers analysis).” Finance exec-utives also advocate range forecasting methods that take risks to forecasts into account. The aerospace/defense CFO, for example, recom-mends against providing “one-number answers” when planning, budgeting, and forecasting, stressing the importance of using models to help move the company “away from wishful thinking and unrealistic expectations that can’t materialize given the parameters/characteristics of the oper-ating environment.”

Our research suggests that technology has an important role to play in companies’ efforts to improve the effectiveness of their planning, budgeting, and forecasting activities. Of the finance executives who use a dedicated (“best of breed”) application for planning, budgeting, and forecasting, more than one-third (39%) say that their technology capabilities have substan-tially contributed to their ability to plan, bud-get, and forecast effectively. (See Table 2.) By contrast, only 5% of finance executives who rely

“PROCESS IMPROVEMENT SURFACES IN THE RESEARCH AS THE MOST VALUABLE CHANGE THAT COMPANIES CAN MAKE IN ORDER TO FORECAST MORE EFFECTIVELY.

“Our technology capabilities have

substantially contributed to our ability to plan, budget, and forecast

effectively.”

TABLE 2 Point solutions, spreadsheets, and manual processes rarely facilitate effective planning, budgeting, and forecasting.

Dedicated (“best of breed”) application for planning, budgeting, and forecasting (n=46) 39%

Financial application module of an ERP system (n=47) 21%

Point solutions with gaps (n=15) 0%

Primarily spreadsheets and manual processes (n=119) 5%

(Percentage of respondents in each category)

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on spreadsheets and manual processes say that their technology capabilities have contributed substantially to their planning, budgeting, and forecasting efforts.

Given that half of the companies represented in our research still rely on spreadsheets and manual processes to plan, budget, and forecast, it comes as little surprise that finance executives at companies of all sizes advise their peers to make technology improvement a priority over the next several years. For example, one controller at a small nonprofit company advises finance teams to “take advantage of planning technologies in the market to overcome any obstacles.” Another finance executive—the CFO of a large health-care firm—says that companies should look to “invest in technology that enables an organization to pro-vide useful, timely information with a prospective look on the market.”

For forecasting, specifically, better use of automa-tion may be especially critical. As one director of finance at a large manufacturing company recommends, “Automate as much of the process as possible; make the forecasting process part of the monthly routine.” As technological transfor-mation continues to push the speed of business, it becomes increasingly important to achieve a tight forecasting cycle—and to make forecasting as reli-able, routine, and mechanical a process as possible.

“AUTOMATE AS MUCH OF THE PROCESS AS POSSIBLE; MAKE THE FORECASTING PROCESS PART OF THE MONTHLY ROUTINE.”

—DIRECTOR OF FINANCE, LARGE MANUFACTURER

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Working Together to Forecast EffectivelyORGANIZATIONAL ALIGNMENT—GETTING everyone on the same page, cross-function and cross-level—is the one planning, budgeting, and forecasting challenge that must always be kept top of mind, according to survey respon-dents. A plurality of finance executives (42%) confirm that organizational deficiencies pose one of the greatest barriers to improving their companies’ ability to plan, budget, and forecast. In open-response questions, finance executives stress the importance of involving sales and operating staff from across the enterprise when developing forecasts. One controller at a large consumer packaged goods company advises, “Demonstrate the benefits of the [planning] process. Also include line personnel in design-ing and building a meaningful set of planning criteria.” Several finance executives echo this controller’s point, and one CFO ties it to the need for better planning technology: “Auto-mate input from the field sales force to begin to develop trends of demand and customer buying indicators,” says this CFO, who works at a mid-size manufacturing company.

Finance executives also advise their peers to enhance the relationship between top-level and mid-level management to improve forecasting. For the director of finance at a large manufac-turer, pushing cultural change from the top down is the most viable route to improvement: “Make sure that the board and high-level execu-tives will pass along the benefits and importance of budgeting/forecasting to mid-level supervi-sors and the rest of the organization,” says this executive. Another director of finance—one at a very large wholesale/retail company—agrees

with this notion, affirming the need for top-level management to establish a performance-man-agement culture and adding that “the planning process then becomes a natural outgrowth of this when everyone becomes aligned.”

Other finance executives recommend working on the relationship between top-level manage-ment and the rest of the company in the other direction: from the bottom up. Says one director of finance at a large energy company, “You must convince leadership that there is real business impact from having resources dedicated to improving underlying business data, obtaining market intelligence, and being proactive rather than reactive to changing market conditions.”

Whether organizational alignment results from top-down pressure or from bottom-up initia-tive, the end goal is the same: to achieve “broad understanding and buy-in as to the goal and benefit of planning and forecasting,” as the CFO of a midsize health-care firm puts it. Says one VP of finance at a large manufacturing company, “It is critical to define what the objective of any plan-ning process is, and to make sure the organization is aligned on that definition. This would include (but is not limited to) what the plan will be used for, how performance will be measured against it, and what level of accuracy is acceptable.” When maintaining profitability demands exploring the unexplored, predicting the unpredictable, and daring to flourish in fallow ground, pulling together the insights and talents of everyone in the organization when developing forecasts may be more than just extremely valuable—it may be necessary for success.

“IT IS CRITICAL TO DEFINE WHAT THE OBJECTIVE OF ANY PLANNING PROCESS IS, AND TO MAKE SURE THE ORGANIZATION IS ALIGNED ON THAT DEFINITION.”

—VP OF FINANCE, LARGE MANUFACTURER

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Forecasting Performance

Sponsor’s Perspective

From our President, Gary Hourselt Forecasts are the result of a collection of processes that can vary not only among different organizations but also among different operating units within the same organization. While processes that culminate in forecasts may vary, the objectives often do not. Better insight and well-founded expectations relative to future financial performance and cash flow seem to be a priority. Re-source requirements including manpower, capital and capacity are needed to meet the challenges of changes in future demand. An overall objective then to improve forecasting is to achieve more accuracy and reliability to avoid potential waste, deficiency, and, of course, surprises, especially for investors and customers. What’s interesting is that much of the variation between fore-casts and actual performance can be caused by the variation in processes and inputs used to create the forecasts. Ideally, the only inputs to a forecast that should vary are the vital few things that will directly drive what is being forecast. So often, assumptions used in forecasting include too many variables, some of which have very little direct impact on what is being forecast. What are the vital few things that will directly drive the performance of your company? Are your forecasting processes standard, clear, con-sistent, and repeatable? Are specific people in your company directly accountable for the vital few drivers of your forecasts and performance? Are they responsible for developing countermeasures when things get off track? Are your strategic plans dictated by forecasts or are your forecasts the result of your ability to execute strategic plans? Forecasts built upon standard processes that utilize the fewest, most vital drivers of performance, are derived from strategic plans that have clear accountability and align-ment among leadership, and combine with countermeasure discipline and superior execution are the most reliable and accurate.

S A Partners USA, Inc.Through our links with the academic community, we maintain our position at the forefront of Lean thinking and feed back real-life learning examples to those studying to become Lean practitioners.

We are firmly focused on training our clients, giving them the appropriate skills and behaviors they need to lead their own continuous improvement activity. We don’t do it for them. Rather we train, coach and mentor those who will take ownership of improvement activities going forward. This is how we create a sustainable legacy. We provide clients with strategic direction and hands-on implementation to guide cultural and organizational transformation. Our approach integrates Lean principles for mar-ket agility and responsiveness across the whole supply chain.

Further Information You Won’t Want to MissYour organization’s ability to forecast reliably is closely linked to its ability to execute strategy. We use proven methodologies for delivering strategy you can actually deploy and execute. Instead of months of volleying up and down the organization, it takes days to develop. Instead of sitting on a shelf and taking a backseat to the financial review, it is the focal point of accountability and alignment. Visit: http://sapartners.us.com/strategy-execution/ for more information.

Forecasting reliably and developing and executing strategy are at the heart of the CFO’s trusted-adviser role in the organization. Creating a Lean Culture within functions under the CFO umbrella, and applying the Lean tools and methodologies in the CFO organization is a way to create the capacity needed to be the trusted adviser the busi-ness needs, without adding resources. Visit: http://sapartners.us.com/cfo-organization/ to learn more.

Leaders who are aligned and accountable are better forecasters because they are best able to execute what makes the forecast real. Our firm provides networking, assessment, mentoring, coaching, and surgeries to create bulletproof Lean Leadership in your organization. With Leadership commitment we expect to see increases in the quality of interactions, in the engagement of employees, in the problem-solving capacity of people at all levels, in the levels of accountability taken, and in the capacity of people to innovate and manage risk. Visit: http://sapartners.us.com/lean-culture/ to get started.

Contact: Kathy Million (919) [email protected]

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