Budgeting/Forecasting

MAKE SURE YOUR PROJECTIONS ARE

HIGH-LEVEL STRATEGY AND NOT JUST A

REHASH OF THE OPERATING BUDGET.

BY P H I L M O N T G O M E R Y

The speed of change in today's economy has generated a trend toward adopting continu-

ous forecasting as part of the planning process. While this type of "rolling forecast"

offers many benefits, organizations often have trouble separating their forecast from and

coordinating their forecast with the operational budget. Instead of truly forecasting—which ideally

should be a higher-level projection—organizations end up preparing mid-year or even quarterly

"re-budgets," with all of the associated effort. The result is a budget that takes too much time and

effort—not a forecast that provides vision and direction.

To gain the greatest benefit from their forecasts, most organizations should step back and alterI 1

their focus from the minutiae to a higher-level, top-down projection that is separate from but

t •

integrated with the operational budget.

February 2002 | STRATEGIC FINANCE 4 1

WHV FORECASTING?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 organi-

zation 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 ailows organizations to close the

gap between the overall strategic plan and the detailed

operational budget.

An ideal planning cycle includes an ongoing forecast-

ing component that flows directly from the overall strate-

gic 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 com-

ponent 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."

Figure 1

STRATEGICPLAN

ONGOINGFORECASTING

DETAILBUDGET

42 STRATEGIC FINANCE February 2 0 0 2

Sales ForecastisstVear

ActualCur YearBudget

Cur rearQI Actual

Cur narq2 Actual

Cur YearQ3 Fcst

Cur Year(HFcst

CwVearPrDJeclion

Sales Staff Headcount

Sales per Staff per Day

Sales ( 0 0 0 s)

Average Gross Margin

Cost of Sales (OOO's)

Commission Percentage

Commission Expense (OOO's)

Net Sales (OOO's)

41.0

1,794

18,389

52.5%

8,735

8.2%

1,508

8.146

45.0

1,850

20,813

50,0%

10,406

9.5%

1,977

8,429

47,0

1,834

5,430

51,4%

2,639

9,1%

494

2,297

44.0

1,805

5,003

50.8%

2,462

8,8%

440

2,101

46.0

1,825

5,289

52.0"..

2,539

9,1%

481

2,269

46.0

1,850

5,276

52,0%

2,533

9.3%

491

2,253

45.8

1,836

20,999

51.6%

10,172

9.1%

1,906

8,920

Rgure 2: The forecaster's inputs should be manageable (and measurable) parameters by which actual performance can be based. In thiscase, fluctuations iti stajfmg, productivity, or profitablitty can be directly compared.

A BEST-PRACTICES METHODOLOGYOnce an organi/.iition has decided to perform strategic

financial planning through rolling forecasts, it should

iLike care that the forecast is focused appropriately and

not simply an extension of the budgeting process. To be

most etfectivc, 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 financlals, metrics, and the like. The process

should be designed to prompt managers and other deci-

sion 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 meaning-

ful "buckets" of information. Minimizing the effect of

monthly aberrations {compared to detailed account level)

reduces the complexity and effort. Managers can focus on

"ihe forest," not "the trees." Likewise, the forecast can be

Iniilt around grouped cost centers, perhaps at a district or

region level, further allowing managers to focus in a more

strategic manner.

Be modeied with operating metrics and parameters

instead of general updates of previous forecast figures.

Ideally, statistical intormation 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 strate-

gic 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 sev-

eral rounds of revisions during the budget finalization

process. A best-practice approach provides for:

1. An easy way for the forecast manager to set mean-

ingful targets for the cost centers that compose the tore-

casted 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, allow-

ing reviewers to concentrate on outliers.

February 2002 STRATEGIC FINANCE 43

RGET PUSH-DOWNR ^ o n l

Yr-To-Date YrTo Date Budget Total

Sales Staff Headcount

Sales per Staff per Day

Sales (OOO's)

Average Gross Margin

Cost of Sales (OOO's)

Commission Percentage

Commission Expense (OOO's)

Net Sales (OOO's)

25.5

1,933

6,212

52,5%

2,951

8,9%

553

2,708

30.0

2,100

15,750

54.0%

7,245

9.1%

1.433

7,072

20,0

1.675

4,222

49.1%

2,150

9.0%

380

1,69]

1,90(1

11,875

S2 O'l-.

5,700

8.5°:-

1,009

5,166

55,0

2,009

27.625

53,1%

12,945

8.8%

2,443

12,237

: utilizing ihe iiiiiic sort of drivers, the arganizaihm's forecast is translulvil lo tiirgcis til ihe mxl-lon't'r levei

ITCOMPANY MFTRtCS

PERSONNEI DATA ANALYSIS

Average Houriy Wage per Employee

Benefit Cost per Empioyee

Paid Time Off as X of Total Wages

Overtime as % of Houriy Wages

OPERATiNG EXPENSE DATA ANALYSiS

Wage & Benefit Expense per Empioyee

Totai Labor-Reiated Expense

Totai Nonlabor Expense

Totai Expense

COHPARiSON TO TARGETS

Headcount

Wages & Benefits

Other Expense

Total

Last YearActual

17,09

13,341

14.2%

13,2%

13,341

456.412

160,422

616,834

CorporateTarget

55.0

633,000

225,000

858,000

CurnarButteet

16.75

6,260

14,1%

13,0%

13,009

461,719

182,751

644,470

DepartmentBudget

56.4

616,660

230,243

846,903

Cur YearProjected

15.89

5,374

13,0%

12.6%

11,266

566,692

220,982

787,674

Variance

1,4

(16,340)

5.243 1(11.097)

NextVearBudget

15.73

5,382

13,0%

9,4%

10,926

616,660

230,243

846,903

Comment

Wbrse Than Target

Better Tlian Target

Worse Than Target

Better Than Target

VarianceAmount

(0,16)

8

0.0%

-3,2%

(330)

49.968

9,261

59,229

11

Percent

-1,0%

0 . 1 %

-2.9%

8.8%

4.2%

7.5%

The top-down tiirgct should he visible lo ih

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 dynam-

ic linkage between the two. It is critical, though, to allow

for different layouts and "owners" of each component.

MAKE SURE IT'S STRATEGYOrganizations must take care to ensure that their fore-

casting process is truly strategic in nature and not simply

an extended budget. By encouraging a strategic mind-

'g the openitiiig hudgct luiil piiniile iiii up lo-iiiite <onip,in>oii.

set, keeping to a summarized level of detail, modelingwith parameters and metrics, and carefully integratingthe forecast with the detail budget process, organizationscan effectively plan for both the short- and long-termfuture. •

Phil Montgomery is a chief considtani at SRC Software with

more than W years' experience creating effective budgeting

and fmancial planning solutions for organizations nation-

wide. You can reach him at PMon,tgomery@srcsofiware.com.

44 STRATEGIC FINANCE i February 2002