Robert Kugel's Analyst Perspectives

I recently participated in a panel discussion about the rise in the use of rolling forecasts in corporate planning. I’m not surprised by this trend; I have encouraged it. Ever since the financial crisis started three years ago, I’ve been writing that companies should rethink how they plan and budget to respond to increasing business volatility. Rolling forecasts are useful because they continually extend the formal planning horizon out more than a year rather than having it stop abruptly at the end of a company’s fiscal year. They can be the right first step in improving the effectiveness of a company’s budgeting process, but ultimately I believe that organizations need to adopt a better approach to planning – what I refer to as integrated business planning. Moreover, companies that want to adopt a rolling forecast approach must first make important changes to their planning and budgeting processes to make them leaner, more focused and faster. The high degree of volatility in business conditions – in particular raw material costs, exchange rates, market prices and even demand – places a premium on having the agility to adapt successfully to these ever changing conditions. And, indeed, companies that spent a couple of months in the fall of 2008 carefully preparing their budgets discovered early in 2009 that the assumptions they had made were useless for running the business. They found the same was true the following year. In trying to become leaner over the past three years, the main adaptation that United States corporations have made has been to shed employees and hire them back slowly. Consequently, those remaining have had to work harder but also smarter. In some cases, this has meant simply eliminating less productive tasks or adopting new approaches to make better use of their time. Overall, I’ve noted small but steady improvements in the use of information technology to improve execution, enhance visibility into business conditions and coordinate actions to make up for having fewer people. This may turn out to be the easy part of adapting to fluctuating business conditions. The tepid recovery of many of the developed world’s economies has validated the basic decision to cut operations to the bone and to operate in as lean a fashion as possible. The sluggishness of business activity in many of these countries has caused lingering expectations of a double-dip recession. For the moment, staying lean in this environment is the least risky approach. But it also can mask the need to do something significant about planning. What happens when demand picks up and companies have to balance their need to meet growing demand with a desire to minimize the risk of becoming overextended? They need to have a better planning and budgeting process in place. The traditional annual budget has served as the closest thing to integrated business planning. A great deal of formal and informal planning goes on in a company, but it tends to be done in local entities and/or functional silos. There are sales forecasts, shop floor plans, headcount plans and others. However, these are only imperfectly integrated into the budget. Indeed, our research shows that the sales plan, which is a major driver of the annual budget, is typically two months out of date by the start of the fiscal year. Not surprisingly, therefore, our benchmark research also finds that fewer than one in 10 companies (9%) react to major change in their operating environment in a well-coordinated fashion. More than one-third (36%) admit they are uncoordinated and more than half (54%) say they are “somewhat coordinated.” Although that might sound innocuous, like a “somewhat coordinated” juggler, corporations that fall short in coordination wind up dropping a lot of balls, and this inaccuracy has an impact on the bottom line. Indeed, more than one-third (37%) of these companies allow that lack of coordination occurs frequently and they spend a lot of time and effort dealing with it. Rolling forecasts do not address the need to integrate business planning, but using them requires a lean planning approach, which is a foundation for integrated business planning that we have researched thoroughly. But I have to caution CFOs and controllers when it comes to adopting rolling quarters: Companies that try to replicate a multiple-month budgeting process four times a year will quickly (and correctly) conclude that it’s not worth the effort. Therefore, at a minimum, the rolling forecast must incorporate only the relatively short list of specific items that are key to managing the business. To support rolling forecasting, driver-based modeling can speed up reforecasting cycles and facilitate lean planning. Driver-based modeling recognizes explicit input and output relationships. Inputs include not just direct items such as materials and labor but also indirect resources such as the number of sales calls (and related expenses) needed to sell the forecasted units. Effective driver-based forecasting models incorporate a units-times-rate structure, keeping “things” such as units sold, headcount, and tons of steel and boxes separate from the monetary value of the units. Thus, as prices change it’s possible to quickly incorporate these into the model. Having a driver-based model makes it easier and faster to incorporate changes to the plan as the impact of changes in forecast sales volumes, for example, will immediately ripple through and show the resources (and change in resources from the last forecast) needed to achieve the forecast. Rolling forecasts can make companies’ planning and budgeting more valuable as a business tool. There’s some evidence that there is growing interest in using it, which I find encouraging. All the best, Robert Kugel – SVP Research

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