(Second of three parts)
The covenants tied to a debt facility are driven by a company’s forecasts. If the forecasts are wrong, then this makes those covenants vulnerable. Yet many businesses still persist with nothing more than annual forecasts.
Kirkbright continues: “To compound the error, many annual forecasts fail to make any sort of seasonal trend allowance, meaning that the business in question can be caught out at a mid-season “pinch point”; i.e. a time of the year when production costs, supplier payments, orders and working capital could all be significantly higher or lower than an annualized forecast would have considered.”
“Significant increases in any cost area can place a massive strain on the banking facilities in place. For this reason, forecasts should be undertaken at least, on a monthly basis, no matter how difficult this may prove for larger, more complex businesses.”
Businesses which think little of irritating their lenders with their poor forecasts can quickly find that their previously cordial banking relationship changes. Having initially dealt with a bank’s sales side, stocked full of people keen to get more work out of a company, senior executives can suddenly find that relationship is handed over to the bank’s restructuring or bad debt teams; something which completely alters the dynamic of the relationship.
The power of the borrower in recent years has meant that they (the borrowers) have held the upper hand, often providing the bank only with whatever information they deemed sufficient. Now, with the access to capital becoming tighter, the balance of power in that relationship has shifted and it is now the borrower who may come under increased pressure to provide more detailed, accurate and transparent forecasts, simply to keep their lender happy.
This is no bad thing however, suggests Kirkbright. “Strong, accurate forecasts can help assure the lender of the short-term liquidity position and of the longer-term strategic direction of the business”, he says. “If the lender is happy, then the forecast has done its job.”
Some key failings
Respondents to the KPMG International survey pointed to three main process areas in which failings needed to be addressed. They were the use of technology, the use of scenario planning and the use of rolling forecasts. On top of that, concerns were raised over the validity and reliability of the data being fed into the system. Finally, there are cultural issues to be addressed insomuch as it is human nature to provide conservative estimates; targets which can be met and exceeded. Such common practices need to be challenged.
Technology and data
Starting with the technology point, it is no surprise that this emerges as an issue when you read that 96 percent of companies surveyed still rely on spreadsheets for at least part of the forecasting process. Forty percent were wholly reliant on them. Spreadsheets certainly still have their place in any forecasting process but there is much more advanced software available to assist companies in this area.
Nearly half the surveyed companies felt that increased automation would be the single biggest step towards gaining increased confidence in their forecasts. However, 35 percent also felt that their current technology was a notable impediment to reliable forecasting.
What this does is to reinforce the need for a single, satisfactory technology platform for forecasting. However, to think that this is the complete answer to the problem would be wrong. The best systems in the world are rendered useless if they are processing unreliable information.
Sadly, 47 percent of respondents felt that the reliability of the financial information they use is merely adequate or worse. Thirty-seven percent even reckoned that the quality of their financial data was actually a notable impediment to decent forecasting. Confidence in their non-financial data was even shakier.
Too many organizations seem to persist with only using limited data sets, such as internally generated historical information and scenarios. Only 40 percent consider government or other economic reports while only 20 percent look at data on non-economic risks. Small wonder then that the two areas in which companies see the most forecasting errors are consumer demand and economic drivers.
One approach, according to Parker is that, “Rather than building forecasts solely around static, detailed, internal data that is relatively easy to predict, leading organizations focus on the key dynamic internal and external business drivers that concern management. These are critical issues such as customer demand, economic activity and economic conditions. Although somewhat more difficult to obtain and predict, these measures provide greater value into the business environment than purely internal details can do.”
“Once this is mastered, the investment in new technology to manage the process becomes more worthwhile. Top performing companies are more likely to use sophisticated software, such as ERP systems, off-the-shelf planning software or bespoke tools in their forecasting.”
“Such technology can be a significant investment though. To obtain its full benefit, organizations should concentrate on aligning both their processes and data with their technology in order to avoid the risks of automating a broken process that uses unreliable data.” (To be continued)
(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)