The ultimate key to credible financial forecasts

How many of you can identify with the organisational environment described below?

Sales are in the middle of a special customer promotion. They're also pursuing a new opportunity which will mean significant extra business above the business plan. The Regional Sales Manager is elated! She will get a bonus if she exceeds her sales plan.

Production has heard many rumours about ‘new business’. But they've heard about these before and it rarely happens. The Operations Director meets monthly, individually, with each Product Manager to get a feel for the market. He then meets with his Planning Manager, compares his ideas with past history and they finalise the production plan. Due to pressure from corporate management, the Financial Director has set an objective to reduce working capital by 20%.

The Production Director just went to a week-long seminar on how to improve equipment utilisation and reduce cost. He's convinced that you can reduce the work force through attrition and simultaneously keep equipment busy on both shifts, thereby maximising utilisation and output.

Distribution got wind of the promotion and decided to lease extra space in Hong Kong to meet demand. Production is traditionally late in supplying warehouse orders, so the Distribution Director has protected himself by ordering more than is really needed.

R&D just discovered a new technology for a new product about to be released that will not only lower costs, but improve quality. However, this means a postponement in releasing the planned product launch until the fourth quarter, instead of the second quarter, as originally communicated to sales. But R&D isn’t concerned, as there aren't any special promotions going on right now!

The Chairman and the Chief Financial Officer just met with a financial analyst and projected revenues to increase 15% in the next quarter, primarily due to an exciting new product to be announced soon, and a 10% improvement in earnings-per-share for the fiscal year. The shareholders are delighted with this prospect.

Unfortunately we have found that this scenario is common in many Asian organisations, where the business is fragmented, people work in their individual departments with silo goals and objectives which often conflict with other areas of the business, the planning horizon is relatively short, and none of the actions are run through a central strategy developed by a collaboration of departments.

An unfortunate product of this fragmented, silo mentality is a multitude of plans and numbers with each department working to different ones.

Unsurprisingly, this lack of a “single set of numbers” with which to run the business makes life very difficult for the finance department who are constantly second guessing what may or may not happen. This leads to a lack of credible financial forecasting – a significant issue for both the CFO and CEO, who are held accountable for the delivery of financial plans by the organisation’s shareholders.

So how can these behaviours be avoided, greater alignment achieved and credible figures calculated?

The key lies in having a modern, regularly updated planning process, which integrates the different areas of the business and produces one “current” company plan and one set of figures that every department works to.

The finance department needs to be involved at every step of the process to ensure when the company plan is developed, with input from each individual business function, everybody understands the financial implications of the bottom-up plans and overall health of the business. That means, R&D understand what is required to achieve a profitable product portfolio; Demand know what is going to be sold to customers in terms of revenue and margin; and Supply realise the cost of fulfilling demand.

One such process is Integrated Business Planning (IBP). An important step in this process is the management review, where once the information from each department has been compiled; the business performance is compared to the strategy.

During this step, finance makes a full assessment of business health over a 24-month rolling horizon – and identifies gaps compared to the financial plan, the business plan and the strategy. This assessment should include P&L projections, the cost of alternate plans, and cash flow and working capital implications. This review occurs on a monthly basis, so any gaps between the new plan and committed plans such as budget and strategy can be highlighted and dealt with in plenty of time. Moreover, during this process the revised forward plan is approved, providing clear visibility and a single set of numbers to drive the business forward.

The results speak for themselves. One organisation I work with, through the development of an effective IBP process, was recently able to identify a $10million shortfall compared to the budgeted profitability in sufficient time to modify the company plan, successfully close the gap and deliver on its committed financial plan.

So for those companies for which the situation at the start of this article sounds all too familiar, a process such as IBP that integrates the different departments, aligns the company plan and produces one set of numbers, is just what is needed. 

Stuart Harman, Partner at Oliver Wight