With macro conditions being beyond any single organisation’s control, businesses are questioning how they can make decisions confidently without knowing how external circumstances may change and impact them.
That brings a particular problem for Finance Directors (FDs) and Finance teams who are tasked with spearheading the budgeting and forecasting process. In the face of such changing external conditions, it is vital that organisations put the foundations in place to allow decisions to be made on a best informed, “no regrets” basis. Doing this will unlock key decisions on capital investment, pricing, salary levels and more, rather than organisations stalling in inertia or indecision.
The quality of your forecasting foundations will dictate how confidently you can plan for these different scenarios and assess the impact of potential options. Running the right diagnostic work will pinpoint exactly how you can improve your forecasting.
There are measures you can put in place now which will impact the reliability of the predictions inherent in your budgets and forecasts. Here are five questions you can ask yourself that will allow you to focus your efforts as you begin to prepare for 2023.
1 Are you making your budgeting and forecasting assumptions clear?
When actual performance is compared to budget or forecast, it is much easier to understand variances if assumptions were fully documented and understood from the beginning. A forecast or budget must be based on information known at a point in time about circumstances. If those circumstances change, then performance will vary from forecast or budget.
Being clear on what the assumptions are when your budget or forecast is set will be key in explaining variations and decisions in due course.
Budgets should also be formally approved by a relevant body within your organisation – usually the board – that has a responsibility to use their own judgement (under Section 173 of the Companies Act). Visibility or clarity over assumptions used in a budget or forecast will enable them to do that with confidence.
2 Do you fully understand your performance drivers?
The more you understand what drives revenue, cost and cashflow in your organisation, the more you can zoom in on the activities you need to focus on to drive growth and find efficiencies. This will also help you to understand the remedial action you need to take if things start to go awry.
For some service businesses it may be that the more time spent on account management, the greater the revenue per client. If so, a budget model for revenue can be driven on the time and resource dedicated to account management, while tracking the account management effort in real time can provide a lead indicator or early warning sign. If time spent on account management dips in month three, for example, it is likely that revenue will drop in month six onwards.
Those lead indicators can be valuable early warning signs for action to be taken – and for forecasts to be updated.
3 How confident are you in the quality of your data?
Access to rich data can improve the quality of budgets and forecasts. Using external data, for example, about the likely performance of a sector can inform your budget or forecast.
You may need to look at a more granular level of detail than simply taking a prior year actual and adding a percentage increase. That is partly because it is hard to find a suitable comparator. 2022 has been a year of political upheaval and supply chain disruption; 2021 was an abnormally strong rebound year for many; 2020 was the year most impacted by lockdowns; and 2019 is sufficiently long ago that customer needs may have changed.
That may explain why we are seeing organisations move to a zero-based budgeting approach, rather than rely on truing up prior periods for their base budget.
One CFO mentioned at the start of autumn that her key focus for budget and forecast 2023 was to “remove the boy who cried wolf”. She found that many colleagues explained away variances between actual and forecast by pointing to perceived poor quality data.
With a readymade excuse, it would be easy to miss a genuine red flag warning and dismiss it as an example of poor data.
4 Is your software robust enough to build an accurate forecast?
There is an increasing expectation that forecasts will be accompanied by several scenarios and sensitivities. Microsoft Excel can still manage that, and it remains the most common budgeting and forecasting tool.
A model that includes only P&L is no longer enough though. A minimum we expect to see is an integrated model of P&L, balance sheet and cash flow in place. Funders and auditors may start to look for more detail in sensitivities around cash flow in the year ahead.
Some organisations that are cautious about 2023’s economic outlook are ensuring that they have a 13-week short term cash flow in place. Our latest showed that one in eight businesses would not have sufficient working capital to manage inflation rising to 11%. Of these one in eight, around half would need to restructure and review headcount in the event of further increases. Better to have short-term cash flow forecast in place and not need it than the alternative.
Where organisations are looking to build more sophistication into their forecasting, we are seeing moves beyond Microsoft Excel and adoption of tools such as KNIME, Jedox, Prophix and Anaplan, among others – or leveraging their ERP solutions such as Oracle.
Having a tool with an appropriate level of sophistication and usability – whether it be Microsoft Excel or not - can greatly improve the turnaround time for your forecasts.
5 How well is your budget communicated between teams year-round?
There is usually a lot of communication between departments in budgeting season. But to maintain good quality forecasts, it is important for that to continue throughout the year.
We are working with an industrials group who led an excellent budget process with very clear communication between procurement, sales, HR and Finance, to co-ordinate all the dependencies and assumptions. Unfortunately, they didn’t maintain the level of dialogue so actual performance quickly diverged from budget and forecast, due to multiple small changes made by each department.
HR couldn’t find the right candidates to recruit, meaning that product innovation lagged; procurement couldn’t access the right raw materials due to supply chain issues, so production faltered; and the sales team focused on one product line for a core customer group rather than the full suite of products.
These elements and adjustments were known and foreseeable – but weren’t communicated and so were never factored into the forecast updates. During economic uncertainty, building resilience to these types of issues will be the way to make cost savings and operational efficiencies. Maintaining that communication is therefore key with Finance keeping an ear to the ground.
As we head into another year of change, accurate budget and forecasting will allow you to fully understand your organisation’s position and make the right decisions at the right time. It will enable you to identify issues and diverse solutions as quickly as possible, allowing you to build resilience and emerge successful.