Effective rolling forecasts: Make sure your projections are high-level strategy and not just a Rehash of the operating budget. (Budgeting/Forecasting).
To gain the greatest benefit from their forecasts, most organizations should step back and alter their focus from the minutiae to a higher-level, top-down projection that is separate from but integrated with the operational budget.
For publicly traded companies, an earnings forecast "miss" can have an immediate and devastating impact on share price. And for both public and private companies, effective allocation of resources mandates that the organization have the best possible understanding of what the short-term and long-term future brings.
Unfortunately, most "static" annual budget processes fail to provide a clear vision of the enterprise's impending direction. Forecasting allows organizations to close the gap between the overall strategic plan and the detailed operational budget.
An ideal planning cycle includes an ongoing forecasting component that flows directly from the overall strategic plan and integrates with the operating budget. The output from this higher-level planning system then directly impacts the outcome of the detail budget.
This principle of a continuous/rolling forecast that drives a target-based detail budget is a key financial component of many organizations' highest-level strategic planning process. The "Strategic Plan" involves many nonfinancial processes (competitive analyses, initiative-focused plans, and the like) and becomes the driver for the rolling forecast. The forecast translates broad-based initiatives into key statistical and operational factors and results. The operating budget, in turn, provides plans and budget-to-actual control functions at the lower levels of the organization (e.g., cost center). Figure 1 depicts an "Integrated Planning Cycle."
A BEST-PRACTICES METHODOLOGY
Once an organization has decided to perform strategic financial planning through rolling forecasts, it should take care that the forecast is focused appropriately and not simply an extension of the budgeting process. To be most effective, a rolling forecast should:
Have a clear strategic financial planning mind-set. While a budget is a short-term plan, the forecast should be focused on long-term strategic financial planning. It's a "big picture" view and should be seen as an opportunity to convert the concepts of the overall strategic plan into specific financials, metrics, and the like. The process should be designed to prompt managers and other decision makers to think outside the minutiae of the budget and short-term goals and instead focus on where the business is going.
Be performed at a more summarized level of detail. The forecast is usually performed at a summarized account level of detail in order to provide more meaningful "buckets" of information. Minimizing the effect of monthly aberrations (compared to detailed account level) reduces the complexity and effort. Managers can focus on "the forest," not "the trees." Likewise, the forecast can be built around grouped cost centers, perhaps at a district or region level, further allowing managers to focus in a more strategic manner.
Be modeled with operating metrics and parameters instead of general updates of previous forecast figures. Ideally, statistical information is gathered, analyzed, and used so that financial and operational indicators--both lagging and leading (predictive)--can be used to drive the forecast. Statistics such as production units, dollars per employee, and dollars per unit are intuitive and quantifiable targets that can be easily compared.
A useful feature of the forecasting system is to visually portray trends of such metrics. For example, a forecast for product revenue might include the historic revenue-per-salesperson ratio and allow a manager to forecast this future rate, in combination with the expected number of salespeople, in order to determine future revenue (see Figure 2 for a parameter-driven forecasting layout). Statistic- or parameter-driven results provide a useful basis for review of the forecast.
Closely integrate with the operating budget. A key concern is how to effectively integrate the ongoing strategic financial planning process with the annual operating budget. In many organizations there is limited (or no) linkage between the two exercises. This usually results in top-down vs. bottom-up disconnects and may cause several rounds of revisions during the budget finalization process. A best-practice approach provides for:
1. An easy way for the forecast manager to set meaningful targets for the cost centers that compose the forecasted entity--utilizing historical data when possible (see the forecast target "push-down" example in Figure 3).
2. Forecasted targets that are visible to the cost-center manager during the budget process. This ensures that even the first budget submitted will be aligned with the forecast goals.
3. Freedom for the budget manager to use his or her judgment in determining how to adjust detail line items in the budget to achieve the forecasted targets provided (see budget target compliance example in Figure 4).
4. An effective feedback loop that compares budgets with the forecasted targets via exception reporting, allowing reviewers to concentrate on outliers.
5. An integrated system to create and manage both the forecast and the budget. A single data store provides for consistent and accurate measurements and assures dynamic linkage between the two. It is critical, though, to allow for different layouts and "owners" of each component.
MAKE SURE IT'S STRATEGY
Organizations must take care to ensure that their forecasting process is truly strategic in nature and not simply an extended budget. By encouraging a strategic mind-set, keeping to a summarized level of detail, modeling with parameters and metrics, and carefully integrating the forecast with the detail budget process, organizations can effectively plan for both the short- and long-term future.
Phil Montgomery is a chief consultant at SRC Software with more than 10 years' experience creating effective budgeting and financial planning solutions for organizations nationwide.
Figure 2 The forecaster's inputs should be manage able (and measurable) parameters by which actual performace can be based. In this case, fluctuations in staffing, productivity, or profit abliity can be directly compared. Last Year Cur Year Cur Year Cur Year Sales Forecast Actual Budget Q1 Actual Q2 Actual Sales Staff Headcount 41.0 45.0 47.0 44.0 Sales per Staff per Day 1,794 1,850 1,834 1,805 Sales (000's) 18,389 20,813 5,430 5,003 Average Gross Margin 52.5% 50.0% 51.4% 50.8% Cost of Sales (000's) 8,735 10,406 2,639 2,462 Commission Percentage 8.2% 9.5% 9.1% 8.8% Commission Expense (000's) 1,508 1,977 494 440 Net Sales (000's) 8,146 8,429 2,297 2,101 Cur Year Cur Year Cur Year Sales Forecast Q3 Fcst Q4 Fcst Projection Sales Staff Headcount 46.0 46.0 45.8 Sales per Staff per Day 1,825 1,850 1,836 Sales (000's) 5,289 5,276 20,999 Average Gross Margin 52.0% 52.0% 51.6% Cost of Sales (000's) 2,539 2,533 10,172 Commission Percentage 9.1% 9.3% 9.1% Commission Expense (000's) 481 491 1,906 Net Sales (000's) 2,269 2,253 8,920 Figure 3 Utilizing the same sort of drivers, the organization's forecast is translated to targets at the next-lower level. Region 1 Region 2 TARGET PUSH-DOWN Yr-To-Date Budget Yr-To-Date Budget Sales Staff Headcount 25.5 30.0 20.0 25.0 Sales per Staff per Day 1,933 2,100 1,675 1,900 Sales (000's) 6,212 15,750 4,222 11,875 Average Gross Margin 52.5% 54.0% 49.1% 52.0% Cost of Sales (000's) 2,951 7,245 2,150 5,700 Commission Percentage 8.9% 9.1% 9.0% 8.5% Commission Expense (000's) 553 1,433 380 1,009 Net Sales (000's) 2,708 7,072 1,691 5,166 TARGET PUSH-DOWN Total Sales Staff Headcount 55.0 Sales per Staff per Day 2,009 Sales (000's) 27,625 Average Gross Margin 53.1% Cost of Sales (000's) 12,945 Commission Percentage 8.8% Commission Expense (000's) 2,443 Net Sales (000's) 12,237 Last Year Cur Year Cur Year COMPANY METRICS Actual Budget Projected PERSONNEL DATA ANALYSIS Average Hourly Wage per Employee 17.09 16.75 15.89 Benefit Cost per Employee 13,341 6,260 5,374 Paid Time Off as % of Total Wages 14.2% 14.1% 13.0% Overtime as % of Hourly Wages 13.2% 13.0% 12.6% OPERATING EXPENSE DATA ANALYSIS Wage & Benefit Expense per Employee 13,341 13,009 11,256 Total Labor-Related Expense 456,412 461,719 566,692 Total Nonlabor Expense 160,422 182,751 220,982 Total Expense 616,834 644,470 787,674 Next Year Variance COMPANY METRICS Budget Amount Percent PERSONNEL DATA ANALYSIS Average Hourly Wage per Employee 15.73 (0.16) -1.0% Benefit Cost per Employee 5,382 8 0.1% Paid Time Off as % of Total Wages 13.0% 0.0% Overtime as % of Hourly Wages 9.4% -3.2% OPERATING EXPENSE DATA ANALYSIS Wage & Benefit Expense per Employee 10,926 (330) -2.9% Total Labor-Related Expense 616,660 49,968 8.8% Total Nonlabor Expense 230,243 9,261 4.2% Total Expense 846,903 59,229 7.5% Figure 4 The top-down target should be visible to the manager preparing the operating budget and provide an up-to-date comparison. Corporate Department COMPARISON TO TARGETS Target Budget Variance Headcount 55.0 56.4 1.4 Wages & Benefits 633,000 616,660 (16,340) Other Expense 225,000 230,243 5,243 Total 858,000 846,903 (11,097) COMPARISON TO TARGETS Comment Headcount Worse Than Target Wages & Benefits Better Than Target Other Expense Worse Than Target Total Better Than Target
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|Title Annotation:||strategic financial planning using forecasts|
|Article Type:||Statistical Data Included|
|Date:||Feb 1, 2002|
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