Forecasting is a top priority for all businesses in a time of uncertainty. The lack of good understanding of the business fundamentals adds unnecessary costs, can put reputation on the line and, in the worst case, even jeopardise a company’s future. One cannot fail to notice the little progress that has been made in the way that forecasts are prepared. Despite being consistently voted a top three priority by accountants, forecasting processes have not materially improved, with a lack of consistency and quality.
Accurate forecasts can be critical to management’s ability to drive and sustain long – term value(KPMG)
Benefits include the ability to ‘recognise opportunities’, ‘manage risk’, ‘set milestones’ and ‘Drive & sustain long-term value’
In the case of new businesses and most SME’s the weakest link remains the lack of understanding surrounding the effect of the fundamental business drivers. That, along with delays in the availability of information, inconsistency across data sources and a poor grasp of financial skills are all causes for concern.
But what constitutes a high-quality forecast? The one thing that is certain is that no forecast will be completely accurate. A high-quality forecast must be built on realistic assumptions, accurate data and reflect the complexities of the business. It must also incorporate a wide range of different scenarios, enabling management to adapt the business so that in any situation the most beneficial outcome can be achieved.
ProForecast creates a model focused on the fundamental business drivers and dynamics, with the ability to run multiple scenarios. Therefore, creating a strategic tool to enable users to explore multiple possibilities and outcomes. By focusing on these areas and using a series of prebuilt models, forecasts can be rapidly built using a wide range of scenarios. This enables an exceptional range of high-quality outputs to be created, at low cost and with exceptionally high “added value” to clients and users.
Traditionally forecasts use historical data to project the future, without looking at the makeup of that data, what the drivers were and what effect future events are likely to have on those drivers. Whereas, for example, by examining the relationship, of price, stock days and sales volumes, the effect of economic changes can be modelled enabling management to strategically plan for the widest range of outcomes.
What’s the alternative?
The alternative to hard-coded forecasting tools is to build an Excel-based model, the most common and widely used solution.
1) The user can have a model that he or she understands.
2) The user can alter it.
3) Excel is cheap and widely available.
1) Reports from both KPMG and PWC have implied that up to 91% of operational Excel spreadsheets used in financial reporting contain material errors that are significant enough to affect decisions.
2) Adaption of an existing excel spreadsheet is a time-consuming option and rarely results in models reflecting the way that the business operates.
3) A custom-built Excel-based spreadsheet will take many days to complete.
4) The time required to customise the outputs limits the quality, availability and comprehensive nature of the outputs.
5) In companies where more than one person is producing forecasts, it is inefficient for them to be duplicating effort by each developing a spreadsheet that they are comfortable with.
6) If the model developer leaves or is unavailable it is often impossible or extremely difficult for another user to use or amend the forecast.
7) It is often difficult for a third party to understand the inbuilt logic so that interventions usually create further errors which can render the model useless.
The ProForecast paradigm enables users to create models using prebuilt modules, so significantly reducing the build time, and radically reducing calculation errors. These modules use the businesses, fundamental drivers, to build a forecast from the ground up, rather than extrapolating existing data. Using the inbuilt global and micro “What If” tools many scenarios can be modelled so that the business is prepared for all outcomes. There are always too many unknown variables so conventional forecasts are seldom realistic models of the businesses’ actual performance, but ProForecast enables users to explore easily and rapidly those possibilities.
When compared with the traditional approach, this method of business forecasting provides numerous benefits in terms of the efficiency and quality of information produced. The process becomes more effective because of it:
· Reduces the need for (and thus dependency on) subjective assumptions and interpretation.
· Uses prebuilt templates to create replicable data sets.
· Can closely model accruals, prepayments and adjust calculation methods to closely replicate the actual business dynamics, which strengthens the forecast accuracy.
· Its focus on the business dynamics increases both the accuracy and the ability to model scenarios based on real-life situations.
· The build consistency is easily understood by third parties, so virtually eliminating errors when colleagues make amendments.
Quality of Forecast
As well as process efficiency, the ProForecast approach also improves the quality of the reports and by deploying computing power instead of subjectivity for the interpretation of raw data, it adds objectivity and consistency that increases reliability and usefulness. Some examples:
1. The forecast responds dynamically to changes in the business environment. The use of a bottom-up approach, utilising the business drivers, makes transparent the relationship between the change in outlook or budget and the update of the forecasts.
2. Root causes of forecast errors can be analysed in detail within the model. Forecast errors are typically caused by incorrect input data and assumptions or changes in lapse time. Volume effects can be analysed by comparing the forecast inputs at different moments in time. This knowledge allows companies to address bottlenecks well before they cause serious damage to the business.
3. The impact of new revenue streams, product lines and business expansion on cash flow and profitability can be analysed quickly and effectively. There is also the option of using “Step Change©” to fully explore the unexpected effects of changes in inputs, with the outputs changing dynamically.
4. This information can be used for defining key performance indicators (KPIs) realistically and monitoring working capital improvement programmes.
5. The financial success of (new) businesses can be tracked. The return on investment (ROI) of proposed (new) businesses is typically based on assumed credit terms and inventory levels. This approach to forecasting pinpoints the root causes of under or outperformance of businesses, assisting business managers with managing their products and markets.
6. Economic scenarios like temporal slowdown of customer payments, volume changes and any combination of factors can be stress tested, unlike conventional globally applied “What If” scenarios. In the real world, changes in economic environment can impact corporate forecasts in many ways. An economic downturn not only impacts sales volume, but also trade credit taken. The ProForecast approach can fine tune each individual factor and clearly show the impact.
The ProForecast model significantly reduces the cost of preparing forecasts, whilst giving the end users a sophisticated “Added Value” report, which will be highly valued by the users, bankers, investors, and other key stakeholders.
For financial advisers, it creates the opportunity to differentiate their services, enhance reputation and generate additional higher fees.
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