High street chain has predictive planning wrapped up. By Richard Barrett, a vice president at ALG Software.
The number of profit warnings issued by UK quoted companies increased by 29 per cent from 2004 to 2005. This is according to research published by Ernst & Young earlier this year. The most common reasons cited were ‘sales short of forecasts’ (45 per cent) and ‘difficult market/trading conditions’ (42 per cent).
Shareholders are entitled to a better explanation and some positive action to avoid further increases in profit warnings. Most chief financial officers (CFOs) want to spend more time managing the future rather than dwelling on the past. The ability to help them prepare quality forecasts is fast becoming a core competence. Some finance functions have a long way to go, but it is possible.
Keeping things on track
One way companies can alter their fortunes is by adopting more frequent re-forecasting methods and by making better sense of non-financial measures when budgeting.
Research conducted by CIMA and ALG Software at the end of last year shows that 91 per cent of 200 FTSE 1000 UK companies report their budget goes off track during the year. More than half want to re-forecast more frequently to address the problems.
As well as ensuring they stay in line with their budgets, more frequent re-forecasting would help organisations manage performance and redefine their strategies if profit shortfalls became apparent. However, 97 per cent of companies surveyed have major barriers to re-forecasting more frequently, with lack of time the number one stumbling block.
The role of spreadsheets
One simple problem is that many have relied on simple spreadsheets to budget and forecast. Using more advanced software could save a typical FTSE 1000 company more than £1m per year, if used to its full potential.
The CIMA and ALG Software survey in 2002 found 74 per cent of respondents reported that spreadsheets were the main tool used for budgeting. By 2005, this figure had dropped to 49 per cent, reflecting a significant financial investment in new software and signalling that things are improving. Unfortunately the results also show that, although organisations are moving away from spreadsheets, they are not re-forecasting any more frequently than those companies still using them.
Respondents were asked to estimate how many days of work it took for a cost centre manager to re-forecast his or her line items. The average from the survey is 2.4 days, compared with 2.9 days in 2004, and 2.6 days in 2003.
Although the amount of time taken to re-forecast has been reduced, three days out of a normal working month - or approximately 10 per cent of management time - is still too long. If re-forecasts are to become more frequent, this time needs to be significantly reduced.
Managers are spending time reviewing and remodelling resource requirements, often for hundreds of line item expenses, but this is the wrong approach. It makes more sense to focus on the key drivers of revenue and costs and build a dynamic budgeting model that also incorporates non-financial drivers.
Case study: moving ahead in stationery
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| WH Smith |
WH Smith High Street, part of WH Smith plc, uses a predictive planning application. This allows its finance and operational teams to forecast the resource requirements of each of its stores, allowing the chain to better align staffing requirements with trading patterns.
A WH Smith’s benchmark study comparing the staff costs and trading patterns of comparable stores discovered a large variation in the amount of operational resources between stores. WH Smith realised a more scientific approach to resource planning was required if these controllable costs were to be reduced.
The company now incorporates non-financial data on activities such as receiving deliveries, stock handling, pricing and customer service into the budgeting process. This enables it to model the drivers of resource consumption and then quickly and accurately predict staffing requirements and their costs.
Fairer budgets
The company now provides managers with fair and equitable budgets, based on the resources required to support the mix of product categories carried by individual stores. It can also generate an annual monthly staffing forecast for each store. This allocation of staff to departments and product lines, based on the better understanding of what resources are needed to support them, enables managers to increase efficiency in-store.
WH Smith also monitors the cost of each product category which, combined with supply chain costs and sales information, provides a clearer view of product and store profitability.
If companies are going to stay on track with their budgets and avoid profit warnings, an integrated approach like that of WH Smith - combining more frequent and accurate re-forecasting while taking account of financial and non-financial data - is imperative.
CIMA will run a Mastercourse, 'Better budgeting and forecasting', on 11 October 2006.