(First of three parts)
In the early part of 2007, results of a research commissioned by KPMG International revealed that senior finance professionals saw forecasting as the area of their business which they were most dissatisfied with. Accordingly, it was ranked as their top priority for improvement in the next three years.
The earlier research was followed up with further research late in 2007 focusing on the topic of forecasting — and some of the reasons behind those respondents’ dismay became all too clear.
The following article is an extended version of the executive summary released by KPMG International incorporating commentaries from KPMG partners from both Financial Management and Restructuring Services that provides interesting insights linking forecasting and business performance. Read on and decide whether forecasting is an art or one critical business tool that should be taken seriously.
Planning, budgeting and forecasting is a process which business executives rarely get really enthused about. Time-consuming, tiresome and just a tick in the box; very few see forecasting as a worthwhile process or one they look forward to. This goes a long way to explaining why so many companies are so poor at it.
They may argue that it doesn’t really matter — but it does. Weaker share prices, poor performance management and missed business opportunities are all symptomatic of poor forecasting. The really frustrating aspect is that it’s all so avoidable.
Inaccurate forecasts to the tune of 13 percent (on average), almost 80 percent of companies unable to supply a forecast to within five percent of actual results, concerns over the reliability of data, the use of inadequate technology, falling share prices — the tale of woe was spelled out across all of the research findings.
Commenting on the results, Scott Parker, Head of Financial Management at KPMG and a partner in the UK firm, said: “Faced with what is undoubtedly a difficult process to master, the last resort of many of the many companies surveyed was to excuse their failings by claiming the process to be ‘more art than science’. They are wrong. It is actually more science than art and needs to be treated appropriately; with rigor and discipline.”
“In addition, too few companies realized the true value of accurate forecasting. It is not just about a channel of communication with analysts and shareholders. Rather it sits at the heart of any decent business performance management program.”
The symptoms
Share prices suffer when analysts and investors react to a significant mismatch between outlook guidance (based on forecasts) and actual results.
When asked how much of an impact a poor forecast could have on their business, respondents owned up to — on average — a six percent hit to their share price. This may not sound like a huge number but it still represents a large amount of market capital — and this is before the damage in terms of lost trust with the investor and analyst community is considered.
However, the research did also show that “poor” forecasters (i.e., those who could not keep forecasting inaccuracies to less than five percent) still saw their share price grow by 34 percent over the course of three years. This is not as impressive as the 46-percent growth recorded by the “good” forecasters — but it may prompt some to wonder why this forecasting issue is such a concern when share prices are still growing at a reasonably healthy rate.
The reason for that is simple, explains Parker. “Good forecasting correlates strongly to good performance management whereas poor forecasting can be symptomatic of a much wider malaise within a business and hints at very real business performance management shortcomings.”
“This is not something which can be lightly disregarded, swept under the carpet or dismissed as not being that important in the grand scheme of things. It really does matter.”
The slippery slope
For anyone who disagrees, Paul Kirkbright of KPMG’s Restructuring Services in the UK points out that when he and his colleagues are called in to restructure a business, one of the first things they have to address — more often than not — is the forecasting process. Perhaps unsurprisingly, in a struggling business, this process is often flawed.
Kirkbright explains: “Poor forecasts are often associated with poor management information in general. They lead to less-than-ideal asset allocation, which in turn can place stress on the company finances. It is quite easy to see this as the first step down the slippery slope towards severe under-performance.”
“Poor forecasts can also make it difficult to identify which areas of the business are under-performing and, in a potential restructuring situation, this may tip a company’s bankers over the edge. If they don’t understand what is going on in a struggling business, then the temptation to call in the restructuring and turnaround experts grows ever greater.”
Clarity of information is arguably more important to lenders than it is to equity investors. Accordingly, nothing will lose the sympathy of a lender more rapidly than a series of missed forecasts, based on poor quality information and with insufficient reasons to explain the failings.
For this reason, when starting a restructuring project, one of the first steps taken by outside advisors will often be to rectify the flaws in a forecasting process in an effort to rebuild trust with the lenders. (To be continued)
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(Marianito D. Lucero is a Principal in the Business and Financial Advisory Services of Manabat Sanagustin & Co., CPAs, a member firm of KPMG International, a Swiss Cooperative. This article is for general information only and is not intended to be, nor is it a substitute for, informed professional advice. While due care was exercised to ensure the quality of the information contained in this article, readers should carefully evaluate its accuracy, completeness and relevance for their purposes, and should obtain any appropriate professional advice relevant to their particular circumstances. For comments or inquiries, please email manila@kpmg.com.ph or mlucero@kpmg.com)