We are experiencing continued headwinds across the economic landscape, and while political unrest may settle down, there are challenges ahead for businesses both in the UK and internationally. With macro conditions being beyond an individual organisation’s control, businesses are questioning how they can respond with resilience and plan a new course.
To emerge successful, decisions need to be made in strategy, recruitment, pricing, supply chain, and beyond. That brings a particular problem for finance directors (FDs) and finance teams who are often tasked with spearheading the budgeting and forecasting process.
There are measures you can put in place which may impact the accuracy of the predictions inherent in your budget. Here are five areas of focus we recommend you begin to address that will support you in your forecasting.
When actual performance is compared to budget or forecast, it will be much easier to understand variances if assumptions were fully documented and understood. A forecast or budget must necessarily be based on information known at a point in time about circumstances. If those circumstances change then no doubt performance will vary from forecast or budget.
Being clear on what the assumptions are when the budget or forecast is set can be helpful in explaining variations and decisions in due course.
A budget or a forecast should never be seen as belonging to the CFO or to finance, it is the organisation’s budget and forecast. We would expect to see budgets being formally approved by a relevant body – 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 can be a key part of enabling them to do that.
The more you understand what drives revenue and cost 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 time to 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.
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. This CFO's goal was to have all stakeholders trusting the data by the end of 2022 so that warning signs aren’t missed in 2023.
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 – a minimum we would 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. That is common practice in many industries but becoming more prevalent across the board.
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.
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.
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. They then 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 particular 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. 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, these tips will help put you in a position to make budgets and forecasts based on best endeavours at a certain point in time.
Our Making Best Informed Decisions series has run for 16 months with regular commentary on specific aspects of the overall challenge. Next month we will be wrapping up the series with a review and re-emphasis of some of the key messages, before we turn our attention to other areas of the CFO Agenda in 2023.
For assistance on forecasting, please contact Simon Davidson.
