The comedian Barry Cryer tells a story about a Finance Director walking down the street. The FD is approached by a homeless man. “Excuse me, mate,” says the man “can you spare me a few quid, I haven’t eaten for two weeks”? “ I see,” says the FD “And how does that compare with the same period last year”?
Of course, no FD would be that heartless but the story also hides a deeper truth – most of us think in fixed periods of time, mainly years and months. This puts us in a situation where we measure financial performance by the distinctly non-financial yardstick of how long it takes the Earth to revolve around the Sun. This is understandable as we measure our lives in the same way – but is it the best way to plan a business?
There has been some movement away from the annual forecasting and planning cycle; I work with several businesses that use rolling forecasts, for example. According to a study by CIMA, about 20% of businesses use them – but what do the other 80% do? Fixed annual forecasts, presumably.
The idea of a fixed annual forecast includes the following assumptions:
• A year is the ideal planning period;
• We can get a good fix on revenues, costs, and profits over that period;
• We can reasonably predict how external economic, political and social factors will turn out.
Let’s think about this a little more. Why is a year the ideal planning period? What if we consider, for example, a five-quarter forward planning period instead? Firstly this gets us away from what I call “the January factor”. By this, I mean that a forecast is prepared and January, (or Q1), shows a marked change from the end of the previous year. Revenues shoot up; costs are magically under control.
In reality fewer changes in most businesses between December and January than at any other time of the year; staff, directors, customers, and suppliers are all off for Christmas!
Yet this happens. Perhaps businesses, like people, make New Year Resolutions – and perhaps they break them too. The fact is, a business is a continuous process; the last quarter of one year flows into the first quarter of the next. Businesses don’t stop and start with a jolt and unless we make changes they will stay the same, yet the planning process often suggests otherwise.
If we choose a different planning period we automatically start to look at the business in a different way. The selected forecasting period needn’t be longer than a year – we might wish a six or nine-month period if we feel that this reflects the nature of the business. A restaurant might have a very different planning cycle from the manufacturer of Oil Rigs, for example. But the selection of an appropriate planning period is key.
This brings us on to the next part of the change in the planning process: if we break away from the notion of the annual planning cycle we can then take it to the next stage, rolling forecasts.
Businesses spend time and resources preparing annual forecasts that run from January to December. That means that at the start of the year they look forward to the next twelve months of activity, but as the year progresses the horizon shrinks. Rolling forecasts enable the business to keep looking up and thinking about the future rather than focussed inward on a set of assumptions that are all too quickly outdated.
What underpins this idea is that in uncertain times (and I would argue that businesses always face uncertain times) the forecasting and planning process needs to be nimble enough both to predict and react to changes in the business environment. A rolling non-annual-based forecasting process enables us to do just that. The non-annual part acknowledges that a business is a continuous process and the rolling part keeps it focussed on change and development.
This is not to suggest that the business should be purely reactive or incapable of setting long-term strategic objectives but that such a mechanism is the best way of reaching those objectives.