Breakpoints in Forecasting

Breakpoints in Forecasting

By Richard Reinderhoff, CFO/FP&A Expert and Independent Adviser

Sometimes, what you forecast needs to change dramatically, due to e.g. market disruption or internal changes. You also might not monitor every business the same way, because each might be in different development stage or ´situation´. By looking at the company itself, but also possible (management) crises, you can determine what the focus of the forecast should be. 

A breakpoint is a point of discontinuity, change, or where things simply stop working. Below are three situations which can ‘make or break’ the forecast. 

1. Full Forecasting

Investing in only forecasting the top-line of the P&L is flawed from the beginning.  It will always be a partial view of reality.

  • At the start of a company, funding is used to initiate the business and to get sales of the ground. If sales are lagging, more funding is needed. This means a longer period of spending. Sales take place later and a higher expense, hence the ROI is suddenly significantly lowered. Someone once wrote, that as an investor you look for very high returns, because it takes twice as long, and it is half as what was expected.
  • Imagine distribution within a region of countries. An out-of-stock situation might have consequences for some countries, but not all. Those countries which do suffer, might increase their marketing spend to regain market share. Overtime at the factory increases costs. Think transfer pricing.

What are you forecasting? There is always a priority when forecasting: Competition (Sales or Assets), Costs (Opex or Capex), or Cash (OP or FCF). Continuously forecasting both P&L and Balance sheet seems valid, and it provides basic input for risk management.

2. No Management Risk

The financial results depend on the decisions and actions taken by management. They are in ‘control’. Many symptoms are part of daily business, which could identify (future) problems with management. 

  • Is the business a one-man show? Does the board participate? How balanced is the top team? Any Non-Executive Directors, as ‘criticasters’ and trouble shooter?
  • Is the CFO visible and present? Does all financial information arrive ‘well’ at the top? 
  • How is the company dealing with change? Any strong outside pressure from peers or ´markets´?
  • How about ethics, social responsibility, or legal issues?
  • Cheap credit, used to sustain the business or to grow exponentially? Management talking about a major project to ‘save’ the company?
  • Are financial indicators becoming weak? Is any accounting ‘work-around’ solutions being promoted?
  • Or, flashy offices, growing customer complaints, staff (and talent) leaving…

What are you forecasting? Here forecasting is about the going concern, without ‘looking’ at the numbers. As a risk it might be called “PR risk” or “succession problem”; that is when someone stops assuming things are in working order. 

3. Portfolio complexity

For lack of a better definition, ‘portfolio complexity’ refers to independent ‘systems’ influencing each other, e.g.: 

  • Carve-out and restructuring: the problem of splitting-up the shared services;
  • M&A: either to access new markets, or to use one’s overcapacity in people and assets;
  • Industry decline and profit margin: pessimism due to consolidations and foreclosures.
  • Regulation and disruption: usage, relevance and the value of intangible assets.

Add, circular economy, PPP investments, or today’s corporations, and forecasting works only if it is a joint activity. 

What are you forecasting? Nothing. In hindsight, this is about planning the future. Here it is about timing, or provisions, contingencies, and restructuring reserves, and how to plan for it. 

These three situations can ‘make or break’ any forecast. It is normal for risk management to be involved and partner with FP&A. Risk management as an overview (the short version) shows: (a) risks & opportunities, (b) level of importance (high, medium, low), and (c) the financial impact. Having one for the running year, and one for the long-range forecast (LRF), is or should be normal business practice bringing balance in any presented forecast.

The article was first published in Unit 4 Prevero Blog

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