Managing uncertainty in a changing business environment

1. Sage Insight
Budget & Forecasting
Managing uncertainty in a changing
business environment
Budget

2. Introduction
Faced with exceptionally difficult
business conditions, organisations
must quickly change their business
activities to reflect the new reality of
the market and of changing customer
needs. This requires a forward-looking
and flexible forecasting system to
anticipate changes, determine their
potential impact and review alternative
responses.
Monthly management accounts
reveal what has already happened,
so it is too late to take any action.
The annual budget is a powerful tool
that gives an early indication of the
predicted business performance in
the next year, allocates resources
and controls fixed costs. However, it
can be a bureaucratic exercise that
brings little benefit for the amount of
management time it consumes. The
business environment often changes
before the beginning of the year, so
budgets are often obsolete before
their year starts.
Several forecasts can be prepared
during the course of the year based
on actual performance to date and
the latest information on trends to
predict future performance. They
are expressed as a series of profit &
loss accounts, balance sheets and
cash flows. However, gathering and
processing all the information can be
quite time consuming. A budgeting
and forecasting system automates
this process, allowing budgets to be
prepared quickly. More importantly,
it allows accurate updated forecasts
to be produced at regular intervals
throughout the year. Forecasts can be
for a variety of time periods:
• quarterly for the rest of the financial
year
• monthly for the next three months
• monthly for the rest of the calendar
year
• monthly for the next twelve months
• weekly for the next few weeks,
then monthly
• any combination of the above.
By quantifying the financial impact
of changes in the business
environment, a forecasting system
allows an organisation to evaluate
different possible scenarios and
conduct “What if?” analyses safely,
without affecting the important data
underlying the forecast. Being able
to anticipate a range of possible
outcomes helps to manage future
uncertainties.
Playing with different scenarios allows
the organisation to explore business
ideas, future growth opportunities or
asset purchases. A good system will
also produce professional reports of
anticipated future performance for
presentation to bankers or potential
investors to secure financial support.
Key questions
• Is your current budgeting and
forecasting system based on your
organisation’s business drivers?
• How accurate are your current
forecasts?
• Do you include non-financial key
performance indicators?
• Can you quickly evaluate alternative
responses?
Sage Insight
Budget & Forecasting

3. In Practice
Spreadsheet hell
The biggest problem with budgeting
and forecasting systems comes from
an over-reliance on spreadsheets,
which are very flexible and fast
to build for a single cost centre,
department or business unit.
However, as more complexity is
added, complex workbooks become
cumbersome, hard to use, time-
consuming and prone to errors.
They are also particularly unsuited to
consolidating cost centre data into a
single organisational budget or overall
forecast.
Robust system
While spreadsheets are general-
purpose tools, budgeting and
forecasting systems are specifically
designed for the purpose. They are
built on a single dedicated database
that is structured and robust and
gathers and integrates all the data
needed. Budgeting and forecasting
software can accommodate a greater
level of detail on departments, cost
centres, business units, territories
and so on and allow combinations of
weekly and monthly time periods.
Data can be imported from a number
of different systems, including
accounting and customer relationship
management systems, and be
calculated instantly into summary
totals that can be presented on
screen using charts and graphs to
reveal trends and patterns. Users can
drill down on the information for more
detailed analysis.
Changes in results will flow
through the model to show the
impact instantly. The process
can be repeated by changing the
underlying drivers (see below) until
the organisation is satisfied with the
overall outcome. Managers will then
have to take action to achieve the
results predicted.
Well designed forecasting and
budgeting systems usually produce
a suite of standard and customised
reports, including key performance
indicators. These reports can
be exported into a spreadsheet,
word processor or a PDF file to
produce management packs that
include narrative commentaries and
explanations.
Forecasting and budugeting software
removes much of the routine work
involved in producing forecasts. This
leaves users free to concentrate on
the vital business assumptions that
underlie their forecasts.
Drivers
Forecasting trends from past actuals
is simple and quick, but in the current
business climate past trends do
not continue into the future. Even
worse, actuals represent an outcome,
without revealing the actual causes of
such performance. They are fine for
fixed costs, that are relatively stable,
but do not reflect the volatility that
characterises the current business
environment.
Forecasts of sales and variable costs
should always be based on causes,
or drivers, of performance, such as:
• sales volumes
• average prices
• advertising spend
• raw materials costs
• energy costs
• headcount
Business managers can enter a
forecast of the volumes they expect
to sell in each period and the average
prices they hope to realise. The
system then collects together all the
forecasts and aggregates them into
one predicted set of results for the
organisation as a whole, in terms of
future profit and loss account, cash
flow and balance sheet forecasts.
(Detailed cash flow forecasting will be
dealt with in a separate SageInsight)
Analysis
The forecasting model provides a
risk-free environment to explore how
price rises, new ventures, expansion
or taking on new staff might affect the
profitability of the business.
This discipline gives senior managers
a much better idea of the impact
external market changes and their
own decisions can have on the
business, making it more likely that
the organisation can capitalise on
potential opportunities and to avoid
potential pitfalls.
Analysing risks will give management
more credibility when seeking
approval for new investment projects
or new funding.
To improve their long-term accuracy,
forecasts should be regularly reviewed
against actual results to identify the
reason for variances, particularly ones
that reflect changes in the underlying
drivers. The forecast should be
repeated during a month if any
significant event occurs, such as:
• loss of a large contract or customer
• delay in a major payment
• dispute of a particularly large
invoice
• if a large debtor becomes insolvent
• a large unexpected increase in a
raw material price
• any adverse business trend
suddenly develops.
Sage Insight
Budget & Forecasting

4. Sage Insight
Budget & Forecasting

5. Tips
• Every forecast embraces
uncertainty and is subject to a wide
range of variables, so fine detail is
not important. It is best to forecast
at a higher level than the budget
and to budget at a higher level than
the nominal ledger. The system
should map the links to ensure
actuals, budgets and forecasts are
comparable. If a new, and therefore
unbudgeted, nominal code is
set up during the year, it will be
assigned to a budget category.
• Identifying profitability drivers and
building them into the software
can be time-consuming, but will
reap dividends. It will not only
improve the speed and flexibility of
forecasts, but broaden and clarify
insight and knowledge about how
the business works and what
factors have a substantial impact
on revenues and costs.
• The assumptions about drivers
built into the software and the sales
forecasts must be realistic, based
on past experience, especially
sales margins, debtor payment
periods and bad debts levels. Sales
volume growth of new products or
new business areas must not be
unrealistically high.
• Reporting results in purely financial
terms is not as meaningful
as reporting the key drivers
themselves, including financial and
non-financial key performance
indicators.
• As the year progresses, the actuals
and budgets start to diverge and it
becomes clear that the budgeted
figures for the latter half of the year
may be exceeded or missed. A
budgeting and forecasting system
enables an organisation to revise
its budget, which is more detailed
than its forecast, during the course
of the year to take account of the
latest developments.
Bottom line
Effective automation of forecasting
and budgeting using specialist
software is fast, efficient and error-
free, encouraging frequent re-
forecasting. Automated reports,
including charts and key performance
indicators, provide managers with
valuable information to support
decision-making.
Specialist software handles structure,
layout and formulae and is much
more suitable than spreadsheets. So
finance managers can concentrate
on the quality of the business thinking
that goes into the figures, which
is what really matters, rather than
producing the numbers.
Fast, efficient and regular forecasting
and modelling is essential for
monitoring the state of the business
and can give managers a much better
appreciation of how their business
works and reacts to changes in
the business environment. It forces
managers to think ahead, recognise
unexpected changes early, anticipate
trends and evaluate the most effective
response.
Used in this way, forecasting and
budgeting software becomes
a powerful management tool
for planning for the future with
confidence. Setting a more stable
future direction of the business will
ensure that it stays on course to meet
its strategic, financial and profitability
objectives.
Links, references and useful
resources
‘Forecasting and Budgeting
Software’, a guide from the IT
Faculty at the Institute of Chartered
Accountants in England & Wales,
£20.00
‘Creating a Budget and Sales
Forecast’ Dun & Bradstreet
‘Top Business Budgeting
Mistakes’ Dun & Bradstreet
‘Better forecasting and budgeting’
Chartered Institute of Management
Accountants, Mastercourse
Sage Insight
Budget & Forecasting

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