Budgeting and reforecasting: last year saw a massive rise in the number of profit warnings. This highlights the issues facing firms using traditional budgeting processes.
Companies have blamed this unprecedented increase on "difficult trading conditions" or "sales falling short of forecasts". But perhaps it is more about poor forecasting. The third annual Reforecasting Report, commissioned by ALG Software, found that the annual budgets of 95 per cent of respondents went off track in 2004. Almost half said that this had resulted from external factors or assumptions about their markets, the competition or the wider economy. A further 29 per cent reported that their forecasts had been too optimistic at the outset.
ALG's and Ernst & Young's surveys underline two facts of life: we live in an increasingly uncertain world and there are frustrations with the traditional budgeting process. With annual budgets averaging a 13-week turnaround, the assumptions that underpin the budget are already outdated by the time it's finalised. This is a simple, yet continuously frustrating, reason for deviations from annual budgets, which can lead to uncertainty among investors about a firm's earnings potential and result in profit warnings.
Investors pay a premium for firms that can reliably predict their quarterly earnings. It's encouraging to note from ALG's report that awareness of the need to reforecast more regularly has risen. The number of respondents who said they wanted to reforecast monthly was six per cent up on 2002, although the number actually doing it increased by, only one per cent over the same period. The number of companies reforecasting quarterly was up six per cent on 2002.
The survey also highlights the fact that, regardless of the applications they used to generate budgeted line items, most respondents recognised the importance of aligning financial and non-financial data when budgeting and reforecasting. This is all important point rather than simply projecting expenses, line managers are using key non-financial data to model their resource requirements and, ultimately, their expenses. On the other hand, when all this information is collated operational planning is still disconnected from the main tool that large organisations use to manage performance: the financial budget.
There are still problems preventing organisations from reforecasting as often or as quickly as they would like. But the focus has shifted. In 2002 and 2003 respondents said that the length of time the finance function took to manage a round of reforecasts was the biggest barrier. By 2004 the issues had shifted more towards line managers, who were resistant to more frequent reforecasting because of the amount of time this would take each month.
If the budgeting and forecasting process is simply the collection and consolidation of revenue projections and line-item expenses, more regular reforecasting is always going to be an issue. Organisations would benefit from moving towards driver-based planning and budgeting that incorporates the operational drivers. Then they can produce a reforecast on request and will have the agility to adapt to the uncertain trading conditions that 2005 is bound to throw up.
Richard Barrett is vice-president of global marketing at ALG Software.
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|Publication:||Financial Management (UK)|
|Date:||Mar 1, 2005|
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