BU SI N E S S P E R F O R MA N C E S E R V I C E S

Three Ds for Improving Your Forecasting Process

ADVIS O R Y

Contents
Decisions Data Discipline Conclusion 2 3 5 7

Forecasting with Confidence, a 2007 study commissioned

by KPMG International and conducted by the Economist Intelligence Unit, reported that almost half of surveyed organizations believe the reliability of their financial data is merely adequate or worse; a majority think the same of their nonfinancial data. Further evidence abounds. Without reliable data, forecasting is not only a waste of time, it is also potentially damaging to your business.
1

The failure of forecasting is particularly painful given the ever-heightening need for it: product and service life cycles are shorter, competition can come from anywhere in the global marketplace, and every company must be flexible and forward-looking to survive. Whats more, the tools and technology to enable better forecasting have matured. Business performance measurement (BPM) applications, now in their second or third versions, are gaining greater integration with major enterprise resource planning (ERP) applications. And these tools are at the disposal of the chief financial officer (CFO), who now takes an increasingly strategic role in the business. What are the stakes in forecasting? Successful business performance is closely tied to better practices in forecasting. For example, share price growth is 12 percentage points higher for the most accurate forecasters; and improved reliability in forecasting leads to improved ability to recognize opportunities (68 percent) and to manage risk (66 percent), according to the same study.2

Forecasting with Confidence: Insights from Leading Finance Functions, KPMG International, 2007, page 2 2 Ibid., page 6
1

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Given the imperative for accurate forecasting, the availability of better tools and techniques, and the recent empowerment of CFOs to implement change, why arent companies more successful in their forecasting efforts? Tools and techniques alone cannot produce successful forecasting. Companies have struggled to forecast with reliability because they havent focused sufficiently on forecasting fundamentals what we call the three Ds: decisions, data, and discipline. Forecasting Tools and Techniques
These tools and techniques, listed from strategic to tactical, are available to CFOs: Automation through information technology (IT) systems and tools More scenario planning and sensitivity analysis Rolling forecasts Reduction in detail and greater focus on key business drivers Improved quality of input data Simplification and standardization of processes Management incentives linked to forecast Formal measurement of forecast accuracy Improved speed to collect and consolidate forecast data Involvement of operational managers Automation through IT systems and tools Training of staff in forecasting (both finance and nonfinance areas) Clear timetables for forecasting Focus on forecasts during periodic performance reviews Frequency of forecasting

Decisions: You need a reason for forecasting, and the reason is leaderships targeted desire to obtain forward-looking information that can facilitate specific business decisions. Data: You must find a way to acquire and maintain accurate, relevant, and timely data that support business decisions. Discipline: The forecasting discipline includes a commitment to managing the business in a forward-looking manner, embedding the forecasting process in the organization, and consistently using forecasting as an element of strategic decision making. Almost every company attempts to forecast in some form or other, but among KPMGs survey respondents, only 22 percent qualified as leading forecasters.3 Clearly, there is room for improvement. CFOs today have the opportunity to increase their forecasting effectiveness by using the three Ds.

Decisions
What makes forecasters effective? And why do effective forecasters do better in the marketplace? Effective forecasters know what theyre looking for and why. Theyre looking for answers to their most pressing questionswhether about north Atlantic weather, the price of silicon, or Chinese investment regulationsto help them make good strategic decisions. They do better in the marketplace because theyve committed to using forecasting consistently and they put that commitment into practice as they lead the company. Taking a page from business reporting history, the first financial data warehouses were built in the late 1990s to help managers answer any question, which added up to confusion and complexity. It wasnt until data marts (subsets of data warehouses) were developed to answer specific issuesfor example, the spending habits of segmented buyersthat the potential of the financial data warehouse came to fruition.

Leading forecasters produce forecasts that are within 5 percent of actual results.

THREE DS FOR IMPROvInG YOUR FORECASTInG PROCESS

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Business Goals Should Drive Forecasting

The goals of forecasting for different companies will be as varied as their strategic business goals. For example, forecasting questions and answers could reflect any one of these strategic goals: Achieve next fiscal years targeted return on investment Plan capital expenditures for the next 18 months Understand new markets and how to contribute to profitability in the next fiscal year Achieve end-of-year budget goals two to four months out Understand the strength of the sales pipeline Provide alternative scenarios to account for weather-related risk Anticipate and control costs through global sourcing Ferret out hidden inefficiencies that accompany sales growth

It is fruitless to task finance with mobilizing people, processes, technology, and controls in a forecasting effort without a sound understanding of the business leadership needsthe questions and decisions that will drive the success or failure of the business. The need for effective forecasting will not come from outside the businessfrom regulators, for instance. Leadership must recognize the potential value of effective forecasting and set about engineering a forecasting process that will address the particular questions the business needs to answer. Leading companies know how to target top-of-mind issuessuch as navigating market uncertainty, establishing governance and controls, increasing shareholder value, and building trust externallyand they focus forecasting efforts to aggregate and filter helpful information in these areas. Is your forecasting process designed to address your strategic business issues? As the forecasting questions become more complex and difficult every year, is your process configured to carry you forward?

Data
Business leaders are hungry for insightful information, which in turn depends on high-quality data. Its not surprising that more than one third of companies (34 percent) believe that improving data quality is a leading way to improve their faith in their forecasts.4 It is obvious that predicting the future is more difficult than reporting on what has already happened. Many of the questions a forecasting process targets require that both financial and operational data be complete. While this is not a simple effort by any means, successful forecasting processes have the following key characteristics relative to data. They: Exploit current efforts Create transparency back to the data sources Incorporate external key performance indicators (KPIs) and data sources. Leaders Exploit Current Efforts Managing the business based on data and information is not new and finance is not being asked to attempt something that the organization is not already doing. To support this core activity, many companies are undertaking data standardization and access initiatives for the purposes of risk management, reporting accuracy and transparency, improved decision making, and better customer relationships.

Ibid., page 12

2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. 070630

THREE DS FOR IMPROvInG YOUR FORECASTInG PROCESS

As a first step, understand and leverage your own companys current efforts around data management to ensure that you are not only creating but also maintaining the key pieces of data that you need for forecasting. In practice, much of the data you need (1) probably exists but isnt refreshed appropriately, (2) may reside in multiple systems, or (3) is not in the form you need. As data warehouses are being standardized for all kinds of purposes, a key requirement is for them to serve the forecasting process. Leaders Create Transparency Back to the Data Sources Assuming you have identified the historical data needed to support forecasting, first determine if it exists in your company and how you can best gain access to it whether it resides on a database, a spreadsheet, or in some analysts head. Second, test the data for transparency: Can you see source detail? Can you slice the data to accommodate your needs? If the data doesnt exist, determine a method for accurately calculating or compiling it, and, just as importantly, agree with stakeholders on that method. A single version of the truth5 is required for forecasting, but that version is valuable only if the method used to determine it is accepted by the business. Leaders Incorporate External KPIs and Data Sources Whether or not you have all the available forecasting information to answer a business question, you can enhance the richness and in many cases the reliability of the forecasting by incorporating external data sources. For example, if you dont have adequate sales forecasting, you can improvise by using industry trends or other third-party data to benchmark target sales numbers. Similarly, external cost trends and industry averages can help to quantify or even qualify a forecast of expenses. Creating standardized relationships between internal and external financial and operational sources can provide both insight and consistency in your forecasting.

5 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. 070630

In computerized business management, single version of the truth (SvOT) is a technical concept referring to how data is selected for analysis. Selection from two or more equally valid representations of input data may be arbitrary, but henceforth sets in stone one and only one version of the truth.

See also Julia King, Business Intelligence: One version of the Truth: Getting there takes more than sophisticated business intelligence software. It takes data quality and political battles, too. Computerworld, December 22, 2003.

THREE DS FOR IMPROvInG YOUR FORECASTInG PROCESS

Driver-Based Forecasting
Rather than building financial plans solely on static, detailed internal data that is merely self-reflecting, leading organizations focus on the key dynamic internal and external business drivers that concern management such as customer demand, competitor activity, and economic conditions. Although more difficult to obtain, map, and predict, these measures provide greater value and insight into the business environment than strictly internal details can. In fact, two of the four areas where organizations see most forecasting errors are ones where such external data might help: consumer demand (38 percent) and economic drivers (29 percent). The most accurate forecasters do look further afield: 68 percent of them use market reports, for example, against just 55 percent of their peers.6

KPMGs research has shown that automation through IT systems and tools, reduction in detail and greater focus on key business drivers, and improved quality of input data are three of the top five factors that provide the greatest benefit in improving forecasting confidence.7 How well does your forecasting effort leverage data quality initiatives that are already taking place in your organization? Have you achieved a single version of the truth in your forecasting calculations and metrics? Are you exploiting external KPIs and data sources?

Discipline
According to Forecasting with Confidence, leading forecasters take accountability more seriously than less-successful forecasters do, are more likely to enhance forecast quality through scenario planning and sensitivity analysis, leverage information more effectively, work harder at forecasting, and benefit their shareholders more. Once leadership commits to forward-looking decision making and management of the business based on ongoing capture and analysis of relevant data, it cannot proceed without a well-designed and sustainable forecasting machine. Thats where discipline comes inthe discipline to: Create a consistent focus on the business issues Develop a single version of the truth Rely consistently on forecast intelligence to make managerial decisions Embed forecasting into the culture. Forecasting should be part of a larger process related to strategic execution in organizations. Its interaction with other major planning and managerial processessuch as strategic planning, budgeting, capital appropriation, monthly and quarterly analysis, and the likeis critical to optimizing its value to the organization.

6 7

KPMG International, op. cit., page 14 Ibid., page 42

2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. 070630

THREE DS FOR IMPROvInG YOUR FORECASTInG PROCESS

Forecasting today resembles quality control in the early 1990s. Quality control departments were typically large and well staffed, but no matter how hard inspectors tried, they couldnt improve quality until they made everyone in the business quality focused. Similarly, leadership today needs to move forecasting out of finance and into the business so that its embedded in day-to-day activities and part of everyones job. Thats a fundamental cultural change, one that requires us to look at ownership of forecasting. Although implementation of forecasting is properly the domain of finance, ownership of the process belongs with the recipient of the results, which is the business. In a 2006 budgeting and forecasting survey conducted by KPMG, 78 percent of respondents said the business owned the budget. While finance was the driver of the process in the majority of cases, finance was the owner of the process in only 19 percent. Forecasting with Confidence (page 33) echoes this view: Leading forecasters embrace forecasting as a core business process, one that engages operational decision makers across the business. They tap into their managers knowledge in real time so their forecasts mirror actual frontline events, and managers remain engaged in the debate about potential courses of action. In this way, operational managers own and are accountable for their forecasts, and they value the process as a crucial management responsibility. Involving the right people in the process also breaks down organizational silos and enables managers to understand how their decisions affect other parts of the organization. As a result, enhanced dialogue, openness, and a level of integration between various parts of the business emerge that enable business managers to use the discipline of forecasting to improve performance. The survey data provide some support for this notion: among the more accurate forecasters, 40 percent are more likely to have operational and line managers do the work, versus 34 percent among the less accurate. Within leading organizations, senior managers sponsor and value the financial planning exercise, are visible and active in reviews, provide clear direction and coaching, and follow up on the actions arising from the process.

THREE DS FOR IMPROvInG YOUR FORECASTInG PROCESS

2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. 070630

In addition, making the budget has been a key driver of behavior and compensation at many organizations. Those companies that have chosen to manage the future as aggressively as the past are striving for the proper balance between making the numbers and positioning for long-term successand theyre aligning compensation with their new management discipline. Understanding what you need to measure and having accurate data available can move your forecasting process forward. However, for the process to excel, all levels of the organization need to collaborate with a common purpose and focus. not addressing the discipline aspect of forecasting severely limits the overall achievement of goals. How much discipline has your organization developed in looking ahead at the business climate? Developing a single version of the truth? Using forecast intelligence as the basis for managerial decisions? Working across silos and embedding forecasting into the culture?

Conclusion
Every business tries to anticipate the future; successful businesses take an active, aggressive role in shaping it. A well-designed and information-rich forecasting process is a prerequisite for this effort. The design, detail, and structure of your forecasting process will be specific to your companys strategy and goals. Customized and accurate forecastingfocused on the critical issues driving your businesss success reveals your single version of the truth. With a heightened demand for better business foresight, the availability of more-evolved tools, and greater potential on the part of the CFO to implement cross-functional change, organizations have the opportunity to develop and leverage their single version of the truthif they keep the proper focus on decisions, data, and discipline. Many companies still live in a world where understanding what has already happened is a challenge, let alone what might happen next. Companies that engage in a process to shape where they are going and where they can outpace their competition have a distinct advantage. Aggressively pursuing a value-rich forecasting process is increasingly a requirement for success, not a luxury. Tools exist. The CFO has permission. now you have the opportunity to take the upper hand by keeping the focus on decisions, data, and discipline.

2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. 070630

THREE DS FOR IMPROvInG YOUR FORECASTInG PROCESS

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