ForecastingThis week, we learned about th
ForecastingThis week, we learned about the importance of forecasting future sales and profit for companies. Of course, there are many factors which can affect the reliability of these forecasts, such as interest rate fluctuations, competitive innovations, new customers, etc. But still, finance leaders must make every attempt to build their business strategy on forecasts that are as accurate as possible.
- As you think about your company’s ability to forecast future sales and profit, what are two or three of the most significant variables that are difficult to predict?
- What information and data would you use to improve the forecast accuracy?
- How can you go about collecting and leveraging this data?
NOTE: If you work in an organization where you have no access to sales and profitability data, you may focus your post on the predictability of other variables that impact things like staffing, product delivery or other operational functions.
Post your initial response by Wednesday, midnight of your time zone, and reply to at least 2 of your classmates' initial posts by Sunday, midnight of your time zone
1st person to respond to Deborah
Hello JP and Classmates.
- As you think about your company’s ability to forecast future sales and profit, what are two or three of the most significant variables that are difficult to predict?
One of Walmart's abilities to forecast future sales and profits, and the most significant variables that are difficult to predict. Walmart wants to tap into its greatest asset, like chasing new business opportunities from bulking up its ad sales to becoming a major health- care provider.
Last week the CEO talks about sustaining momentum as some coronavirus pandemic-related tailwinds fade and online sales as well.
This would discounter a weave together, and diverse services customers want, from credit or debit cards, buy groceries and also increase investments to cater to customers, changed shopping habits. Walmart talked about scaling new capabilities and businesses and designing them to work together, this would help them to build an ecosystem of products and services to deepen loyalty and win more customers.
The results and its forecast for moderating sales in the year ahead prompted a sell-off. Walmart shares closed Thursday down 6.48% to $137.66. Its market value is now $389.48 billion. In the fiscal year, Walmart grew its revenue by $35 billion, but higher sales alone won’t get it to higher profits.
- What information and data would you use to improve the forecast accuracy?
Walmart relies on big data to get a real-time view of the workflow in the pharmacy, distribution centers, and throughout our stores and e-commerce. (https://corporate.walmart.com/newsroom/innovation/20170807/5-ways-walmart-uses-big-data-to-help-customers)
- How can you go about collecting and leveraging this data?
Walmart has a broad big data ecosystem. The big data ecosystem at Walmart processes multiple Terabytes of new data and petabytes of historical data every day. The analysis covers millions of products and hundreds of millions of customers from different sources. The analytics systems at Walmart analyze close to 100 million keywords on daily basis to optimize the bidding of each keyword. The main objective of leveraging big data at Walmart is to optimize the shopping experience for customers when they are in a Walmart store, browsing the Walmart website, or browsing through mobile devices when they are in motion. Big data solutions at Walmart are developed with the intent of redesigning global websites.
Deborah
References: https://www.nytimes.com/2022/07/25/business/walmart-lowers-profit-forecast-inflation.html
https://www.projectpro.io/article/how-big-data-analysis-helped-increase-walmarts-sales-turnover/109..
2nd person to respond to Thiago
Hello Professor JP and Classmates
As you think about your company's ability to forecast future sales and profit, what are two or three of the most significant variables that are difficult to predict?
Indeed, predicting the future is never easy, where assumptions are taken based on historical data, macro/micro economic indicators, regulations, etc. As such, the forecasting has a certain level of uncertainty which can be reduced with proper planning and data management. As far as Halliburton's forecast is concerned, the main two variables that need continuous updates are inventory and labor, which directly affects the efficiency ratios such as Asset Turnover and Inventory Turnover. That's why it is critical to review the forecasting periodically.
What information and data would you use to improve the forecast accuracy?
Asset management and the Human Resource departments are constantly scrambling, moving, and managing assets globally to dynamically meet market demand and hire and train new employees to execute the service. Since the oil and gas industry is dynamic, cyclical, and volatile, predicting is a tough challenge. However, any information that affects the price of the barrel of oil is helpful when it comes to forecasting since it directly affects the volume of operations.
How can you go about collecting and leveraging this data?
Honestly, I am unsure how and where the Finance department collects the data. I believe that any source of data: journals, newspapers, TV, websites, social media, etc., would support data collecting to analyze trends and forecast revenue, inventory, and labor. For example, the oil price recently soured, which immediately affected the demand for our service. Thus companies "operators," to make more profit, decided to drill more wells and increase production, which requires more labor and inventory to increase capacity. Ultimately, companies will never make game-changing decisions only by using hard data. Senior executives should rightly value 'unstructured data' gained through conversation with peers, their own experience, and in sampling the views of suppliers, consultants, and customers. However, the opportunities presented by data and analytics will provide a competitive advantage to those who invest in it (1).
Sincerely
Thiago Andrade
Reference:
- O’Mahony and Lyon. Planning, Budgeting and Forecasting: An eye on the future. JWI531, week 5 material.
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JWI 531 (1202) Page 1 of 9
JWI 531: Financial Management II
Week Five Lecture Notes
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JWI 531 (1202) Page 2 of 9
FORECASTING AND PLANNING What It Means Forecasting is the financial lens through which the business plans of an organization are analyzed. While forecasting is both an art and a science, there are proven tools and practices financial analysts use to build predictive models incorporating past trends, current risks, and opportunities. Based on these forecasts, budgeting tools are then applied to develop a plan needed to fund strategic initiatives. Why It Matters
• Every strategic initiative an organization considers will be based on forecasts. The more accurate the forecast is, the more successful the plan will be.
• Financial leaders are key members of the strategy team, and will be relied upon to develop
accurate forecasts based on economic conditions and market dynamics.
• The strategic planning process of building models for future cash flows requires that you identify all of the assumptions being made about an opportunity. This comprehensive process enables the team to be more thorough in their decision-making.
“Budgeting is about opportunity. The only two measurements that count are how did I do against the prior year and how did I do
against the competition: that’s what creates shareholder value.”
Jack Welch
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JWI 531 (1202) Page 3 of 9
THE CHALLENGE AND OPPORTUNITY FOR MANAGERS
It’s impossible to imagine any organization making important strategic decisions without thorough analysis. For plans that require a significant commitment of capital, you can be certain that proven forecasting techniques will be used to analyze opportunities and risks, and to develop a budget for the strategy. Unfortunately, budgeting may be the most cringe-worthy word in business vocabulary. But why is that? And, more importantly, what can we do to change this? Instead of being a positive process that encourages people to think big and plan how to put the organization’s strategy into action, too often, the budgeting process becomes a time-consuming game. But if you can end the “budget game” and focus on more useful information, you can empower managers with better tools to run their businesses. If you want a seat at the table where strategic opportunities are discussed and planning decisions are made, you need to understand the principles upon which these decisions rest. Forecasting is always a part of this process. If you can’t contribute to this analysis or understand the terms being used, your ability to impact these decisions will be severely limited and your business’s strategy may never get off the ground. The challenge with forecasting, of course, is that it’s basically a prediction. Predictions take events, trends, patterns, and behaviors that have happened in the past, and extrapolate to develop probabilities about what will happen in the future. If the forecasts turn out to be correct, and if the business has a viable plan to capitalize on them, it can make money. Forecasting and planning require the identification of a range of possible outcomes that could occur, narrowing that range to the most likely best- and worst- case scenarios, and developing a financial strategy that maximizes upside potential and minimizes downside impact within the forecasted range. Still, it’s not unusual to have a group of seasoned and successful business leaders working together to develop a business plan, and to have each of them come to the table with a very different set of assumptions and forecasts. Understanding and leveraging the tools of budgeting is critical to testing various scenarios and developing a financially defensible business strategy. The materials we cover this week will help you strengthen these skills and deepen your understanding of these critical processes. Your great ideas deserve nothing less!
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JWI 531 (1202) Page 4 of 9
YOUR STARTING POINT
1. Are you as involved with strategic decisions in your organization as you would like to be? If not, why not? If so, do you feel comfortable with participating in all aspects of this process?
2. What are the most difficult metrics to accurately forecast in your business? Why is that? Which ones are the easiest to accurately forecast? How can you leverage additional data sources or team members to help you improve the accuracy of your forecasts?
3. Do you feel the budgeting process in your organization is as effective as it could be? If not, why not? Does the budgeting process at your organization feel like a chore, or a strategic planning process? How can you make it more like the latter?
4. When building forecasts of future cash flows, does your team use flexible models that provide a range of possible results to analyze?
5. How frequently do you compare actual results with planned results? Do you think you do it often enough? Why?
6. Do you have a great idea for a new strategic initiative? Draw out an investment timeline and
forecast the cash flows you’d expect. Change a few assumptions and recalculate the results in order to get a sense of how changes in assumptions impact the viability of the idea.
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JWI 531 (1202) Page 5 of 9
FORECASTING AND PLANNING Looking into the Crystal Ball Forecasting and planning are about modeling what the future might look like if you follow a specific strategic opportunity. While it’s impossible to know the future, you will be better prepared to make decisions and execute if you have put the work into planning. This means:
1. Identifying all of the assumptions you have to make about the future (e.g., costs, revenues, market share, market size, competitive environment). You can count on having these assumptions challenged and that’s okay – you’ll be prepared if you’ve done your homework.
2. Putting cash flows against those assumptions. Cash flows, not revenues and expenses, are the building blocks of forecasting. You must build models that allow you to test the sensitivity of the financial results to changes in your assumptions.
Modeling…Bad Behavior? Bragg begins his chapter on budgeting and forecasting with an acknowledgement of the challenges financial leaders face in most planning processes.
“The corporate budget is one of the principal documents used by a CFO to gain an understanding of where a company is supposed to go, and how to get there. However, the budget has also fallen into some disrepute, since it can lead to a variety of negative outcomes, and can diverge so wildly from actual results that it is essentially ignored.”
The CFO Guidebook, p. 131 To illustrate the pros and cons of forecasting and planning, Bragg presents a summary outlining the advantages of having a formal process, including orientation for stakeholders, scenario modeling, assumption reviews, predicting cash flows and costs, and even investor communications. He then outlines an even longer list of the downsides, including inaccuracy, rigid decision making, and gaming the system (pp. 131-134). He summarizes these challenges as follows:
“The single most fundamental problem underlying the entire concept of a budget is that it is designed to control a company from the top. The basic underpinning of the system is that senior management forces managers throughout the company to agree to a specific outcome (that portion of the budget for which they are responsible), which senior management then monitors to control the activities of the managers. This agreement is usually a formal agreement under which each manager commits to achieve a fixed target in exchange for receiving a bonus.”
The CFO Guidebook, p. 135
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JWI 531 (1202) Page 6 of 9
It is this last point, the risk of negative behaviors driven by rigid bonus models, which underlies much of Bragg’s critique of the self-reinforcing systems and bureaucracy needed to control budgets. Planning and Control Budgeting is about two elements: planning and control. Organizations set goals and identify the resources necessary to meet those goals: time, people, materials, and money (planning). They must then monitor financial data as they unfold and manage adjustments in operational activities (control) to ensure that actual outcomes are as close as possible to what was budgeted.
• When you hear the word budget, you should be thinking of it as a plan to operationalize the organization’s strategy, describing the results you expect in the near term and the resources you’ll need to achieve those results.
• A flexible budget is one that uses the same estimates for costs as the original budget, but is set at the same volume or activity level as the actual results.
• When actual results start to come in, differences between the plan and these results can be measured. These differences are what financial managers call “variances.”
• In the language of budgeting, all of the work to keep the actual results on track and achieve the goals set out in the budget is called “control.”
During the period covered by the budget, variances provide feedback on where to direct attention and corrective action to get the business back on track. If market conditions with customers and suppliers change significantly after the budget is made, then variance analysis can provide inputs to update the budget. When the actual level of revenue is greater than planned or some actual cost is lower than planned, this variance is called “favorable.” When the opposite occurs, the variance is referred to as “unfavorable.” Finding a Better Way Before managers and business leaders can consider changes to the financial planning process, they must understand how the models are typically structured. Bragg provides an excellent summary of the “system of budgets” (pp. 138-144). Read it carefully to help you better understand the organization and dependencies of different budgets, as well as what levers can be pulled to improve the process. He also presents a consideration of alternatives to even having a budget. While this may seem ridiculous at first, it may not be as radical as it sounds. He introduces the idea of a rolling forecast as follows:
“A good replacement for a budget is the rolling forecast. This is a simple forecast that contains information only at an aggregate level, such as:
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JWI 531 (1202) Page 7 of 9
• Revenues by product line • Expenses aggregated into a few line items • Customer order backlog • Cash flow
The intent is to create a system that is easily updated, and which gives the organization a reasonable view of what the future looks like for at least the next few months. A key reason for having a rolling forecast is to bring up issues as soon as possible, so that a company can initiate corrective actions to deal with them. Thus, the goal of a rolling forecast is not to attain a specific target, but rather to provide early notice of problems and opportunities.”
The CFO Guidebook, p. 147 From this jumping off point, he addresses several connected topics, including goal setting without a budget, strategy without a budget, reduction of bureaucracy, and even building compensation models without a budget. These will definitely give you some ideas for reconsidering the status quo. In Summary The future will never look exactly as you planned. One way to deal with those inevitable changes is to make sure that the models you’re using to make decisions are flexible enough to adapt to changing or unanticipated conditions. It’s not that businesses shouldn’t make plans based on forecasts. Of course they should. It’s about getting every brain in the game and working with financial leaders to develop processes that drive the behaviors needed to win – not just to beat the budget. The forecasting and planning process must be one in which information is shared more broadly, in which a culture is created that ends the gaming of the system, and in which team members are united around common values and metrics.
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JWI 531 (1202) Page 8 of 9
SUCCEEDING BEYOND THE COURSE
As you read the materials and participate in class activities, stay focused on the key learning outcomes for the week and how they can be applied to your job.
• Explore the challenges of forecasting in developing a sound financial plan Take your “best big idea” and put it through your own forecasting and budgeting process. The best way to become familiar with the language and techniques of planning is to practice. What forecasts about cash flow will you have to consider to determine if the idea makes financial sense? Don’t worry initially about the accuracy of your forecasts. Just start by identifying what forecasts you will need to consider to develop a well-researched plan. Visit the finance department and get their guidance on what criteria should be used to analyze your ideas.
• Assess the reliability and application of key predictive indicators You have identified the forecasts you will have to consider in building your financial plan. This may have been quite simple or complex, depending on the scope of your big idea and whether it is an evolution of your company’s current core business or an untested venture. Now, you must assess the reliability of the predictive indicators that inform your forecast. Generally speaking, forecasts are most reliable when they are: (a) focused on near-term events, and (b) where the historical trends have been consistent and connectable to clear drivers. It’s okay if you have to make some assumptions – all business planning requires assumptions. The key is to be clear on what sources you are leveraging, what parameters represent reasonable best- and worst-case scenarios, and what risk events could undermine the forecast. This is a great time to review your course materials from Week 2.
• Evaluate options for goal setting and compensation relative to forecasts
Whether you are a manager setting performance goals for your team, or you are working with your boss to set your own performance goals, it’s important to have honest conversations about how the business forecasts were arrived at, and what it will take to get there. Jack is a strong advocate for candor in this area. The forecasting techniques we’ve looked at in this course are popular across a variety of organizations, but every business is different, and the reliability of a forecast for a company that has decades of data behind it is going to be different than those of a startup or a new product offering. The bottom line is that you want to set your team up to win. Creating goals that are excessive or have little data to support them can lead to disappointment. The best principle is to set performance goals so that if the team knocks it out of the park, the people who generated the results get rewarded.
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JWI 531 (1202) Page 9 of 9
ACTION PLAN To apply what I have learned this week in my course to my job, I will…
Action Item(s) Resources and Tools Needed (from this course and in my workplace) Timeline and Milestones Success Metrics
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