Budgeting and Rolling Forecasting

Transcription

1 Budgeting and Rolling Forecasting Accounting for Management Control September 29, 2015

2 Agenda Traditional annual budgeting Remedies to budgeting problems Rolling forecasting Relative targets Why to forecast How to forecast Beyond budgeting Principles Case Borealis 2

3 Budgetary control Set targets Prepare budgets Compare target to budgets Significant deviations? Feedforward control Accept and implement budgets No Yes Take control action Record actuals Action No Compare actuals and budgets Significant deviations? Yes Forecast results Compare forecasted and budgeted results Feedback control No need for action Take control action

4 Rolling forecasting Why do companies need rolling forecasts? How to forecast? 4

5 Why to forecast? Investor relations Measurement Management Is the purpose to: a) get accurate view of the future? b) make better decisions?

6 Traditional vs. rolling forecasting Latest Estimate Ytd 1 Ytd 2 Ytd 3 1 Jan 31 Dec Scenario Planning Rolling forecasts Ytd 1 Jan 31 Dec

7 Forecast period How long into the future to forecast? Lead time between decision and the impact (reaction time) What is the longest reaction time in the business? Reaction time varies between industries and within a company Calendar year (fiscal year) is hardly the best period? How often the forecasts should be updated? How often revenues / costs change? How often environment changes? How often key assumptions change? Is it reasonable to forecast everything in the same cycle?

8 Freedom of choice increases Different forecasts PURPOSE PROCESS Strategic planning Business forecasting Operative forecasting Degree of certainty increases ADAPTATION How to structure the business cost-effectively Creation of options ANSWER How to make the best use of resources Decision-making REACTION How to satisfy demand effectively Implementation ADAPTATION Alternative scenarios of the future environment Broad lines Freedom of choice ANSWER The most likely estimate of what is going to happen based on current assumptions Detailed enough Limited freedom of choice REACTION Prediction of what will happen Very detailed Limited choice

9 IMPORTANCE Low High How often and what to forecast? VARIABILITY Low High Routine update on quarterly basis or as needed Routine monthly update Check on quarterly basis and update as needed Routine quarteraly update

10 Forecasting frequency South West Airlines Economic significance Variability Importance of rapid response Update frequency Revenue High High High Daily Month Forecasting horizon Labor High Low Medium Twice a month 6 months Petrol High High Medium Weekly Quarter Maintenance Medium Medium Medium Twice a month 6 months Marketing Medium Medium High Monthly 6 months Depreciation Medium Low Low Qaurterly Year Airport fees Medium Medium Low Weekly 6 months Other Medium Medium Medium Twice a month Quarter

11 Forecasting process Input Processing Output Assumptions Model Forecasts Environment Industry trends Acitivites Judgement Mathematics Statistics Momentum (direction) Interventio (actions) What is forecasted? Trends Past patterns that will repeat themselves in the future Without trends forecasting would be impossible Discontinuities Trend disturbances, surprises Chaos (financial crisis 2008 ) Novelty

12 Judgement Judgmental model Commonly used Based on experience E.g. inflation Benefits Easy, inexpensive, rapid and accommodation of complexity (to the certain extent) Weaknesses Insufficient in large scale and scope (complexity) Difficult to reforecast (no scale benefits) Depends on the skills of the forecast producer Systematic bias (positive / negative) E.g. a manager is reponsible for a cost budget and the company seeks cost savings. What is the likelyhood that the manager will forecast cost reductions? How about cost increases?

13 Mathematical model Basic idea is: to address causal relationships between various factors and model them mathematically Methods Activity-based budgeting / forecasting Driver-based forecasting AMEX: building the model Controllers to the business units If you had to forecast each line of the P&L by using a driver and an algorithm, what would you use Results: 11 models in the web-based application

14 Driver-based forecasting Marketing Call Center Production Marketing activities Response rate Incoming calls Success rate Sales volume Plan marketing resources and activities Plan call center resources and activities Plan production resources and activities

15 Driver-based forecasting Traditional budget Driver-model: call center labor Gross sales Input from marketing Incoming calls per month Discounts Modelling Days per month 20 Net sales Calls / person / day 75 -COGS Peak factor 20% Product costs Cost / person / month Call center labor Capacity/ person / month 75 x 20 = 1500 Other Required people (200 /1,5 )*1,2=160 Gross margin Labor costs / month 160 * = R&D Output to production Success rate 16% -Sales Incoming calls per month Administration Sales / month 16% * 200 = STRATEX Operating profit

16 Statistical model Complexity Statistics is the only way to forecast complexity Statistical model Finds out patterns of the data Does not explain why some pattern occurs Is more simple than mathematical models Is based on the assumption that history repeats itself (adjustments of data) Pros Rapid and inexpensive (once the model is built) Free of motivational bias Cons Not actionable (relationships, no causal explanation) Ignores surprises (trends, but no suprises)

17 A model or joint application? Base volume (S) Sales and marketing activity (J) List price (J) Revenue model (M) Revenue forecast Discounts (J) Profit forecast Material price (J) Processing (S) Cost model (M) Cost forecast Waste (J) S = statistical, J = judgemental, M = mathematical

18 Summary What to forecast? Fundamental business drivers Variability + significance keep it simple! When to forecast? Issues change in different cycles horizons and frequencies All costs are ultimately variable if the horizon is long enough Who do the forecast? Inputs from responsible managers Modelling and updating by F&C

19 Beyond budgeting 19

20 Budgets cause wrong behavior How to win the budget game Negotiate lowest targets/highest rewards Always make the bonus, whatever it takes Never put customers above sales targets Never share knowledge and resources Always ask for more than you need Always spend what s in the budget Always explain away adverse variances Never provide accurate forecasts Always meet, never beat the numbers Never take risks

21 BB:Leadership vision 1. Climate Predictive & Centralised Performance contracts 2. Motivation Plans & incentives 3. Devolution Constrained to plan 4. Empowerment Bureaucratic red tape 5. Organisation Centralised hierarchy 6. Information Closed & controlled Adaptive & Devolved Competitive success Responsibility for outcomes Freedom to decide Capability to act Customer focused teams Open & one truth

22 BB:Finance vision 1. Targets 2. Rewards 3. Strategy 4. Resources Predictive & Centralised Negotiating fixed targets Paying individual incentives Centrally driven, annual event Allocated annually thru budgets 5. Coordination Predetermined by central plans 6. Control Top-down thru variances to plan Adaptive & Devolved Setting relative measures Recognising team-based success Devolved, inclusive & continuous Free access with accountability Dynamic market-like processes Multi level, fast and open

23 Tools in use Borealis - Europe s 2nd largest petrochemical company. Financial planning Qtrly rolling forecasts, not linked with performance management Target setting Balanced scorecard to set targets and measure performance Controlling fixed costs Trends, activity accounting, ABC and SAP Budget Resource allocation Trends (s), Hurdle rates (m), Case by case (l)

24 Standardization Performance measures Competitive position Brand equity Market share Customer satisfaction Product reliability Outputs Process Inputs Few Aggregate Number and nature of measures Many detailed Market value Residual income ROCE P&L + current assets P&L Sales revenue Manufacturing costs Operating expenses Wide narrow Wide Span of accountability

25 Dynamic resource allocation Do I have budget for this? Is this correct thing to do? -Supports strategy? -Decision criteria? -Can I justify it? Budget Bad thing! OK OK? OK? OK? OK? OK? 25

26 Dynamic resource allocation ABSOLUTE KPIs RELATIVE KPIs NO KPIs Traditional cost budget Absolute cost KPI Unit cost input/output Benchmarked unit cost Bottom line Strategic targets/ activities Xx Xx Xx Xx Xx / unit / customer / employee 1st quartile above average EBIT ROCE (abs./relative) Cost efficient operations Reduce the use of external services Monitoring of actuals, intervention only if needed Choose which fits best in your organization Increasing freedom and flexibility Increasing need for strong values and clear direction (strategy, objectives) 26