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From the blog: would a five-quarter year make the FD’s life easier?

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 joke hides a deeper truth: that most of us think in fixed periods of time, mainly years and months. We end up measuring financial performance by the distinctly non-financial yardstick of how long it takes the earth to revolve around the sun. Yes, that’s how we measure our time, 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 and according to CIMA, some 20 percent do too. But what do the other 80 percent do? Fixed annual forecasts, presumably.

The idea of a fixed annual forecast includes the assumption that a year is the ideal planning period, that we can get a good fix on revenues, costs and profits over that period, and that we can reasonably predict how external economic, political and social factors will turn out.

Just give it a bit more thought and you come to the question: why is a year the ideal planning period? What if we consider a five-quarter forward planning period instead? That gets us away from what I call the January factor, by which 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, however, most businesses experience much less change between December and January than at any other time of the year; staff, directors, customers and suppliers are all off for Christmas.

Yet this goes on happening. Perhaps businesses, like people, make New Year resolutions and perhaps they break them in the same way. The fact is that 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. But our 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 have a six- or nine-month period if we feel it reflects the nature of the business. A restaurant might have a very different planning cycle from an oilrig builder. But the selection of an appropriate planning period is really important.

Which brings me 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 move to rolling forecasts. Businesses spend time and resources preparing annual forecasts that run January to December. At the start of the year, they look forward to the next twelve months of activity, but the horizon shrinks as the year progresses. Rolling forecasts enable the business to keep looking up and thinking about the future, rather than focusing inward on a set of assumptions that are all too quickly outdated.

What underpins this idea is that in 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 that. The non-annual part acknowledges that a business is a continuous process and the rolling part keeps it focused on change and development.

That’s not to suggest that a business should be purely reactive or incapable of setting long-term strategic objectives. Rather, such a mechanism is the best way of reaching those objectives. 

And don’t even start me on why the tax year starts on the 6 April…

Matthew Howes is principal in the London business of The FD Centre

This article originates from our monthly blog, Shareholder Values, which you can follow at http://www.financialdirector.co.uk/blog

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