"There's only one thing you know about your forecasts," says Steve Morlidge, former controller with Unilever Foods and currently director of consulting firm Satori Partners. "They will be wrong."
Forecasting, he explained at the recent Beyond Budgeting conference in Houston, is really all about decision-making. You first need to work out where you are heading, which is the forecast, and then when things change as they always do, you have to figure out what you need to do differently to get back on track.
A good forecast, Morlidge said, is timely, actionable, reliable, aligned and cost-effective. "There should only be one set of forecast numbers," he added, "but the unpredictable nature of the world needs to be taken into account."
"Unpredictable" certainly describes the situation facing most large public companies when it comes to forecasting their working-capital needs. According to a recent study conducted by REL Consulting, most companies are not able to accurately forecast such operational basics as inventory, receivables, payables and the cash requirements needed to support them. In fact, companies typically miss their working-capital forecasts by as much as 23%, which for a Global 1000-sized company represents $600 million.
"In some ways, forecasting cash is even more critical than forecasting earnings or revenue," says Veronica Heald, director of REL Consulting. "You can take a hit quarter after quarter for missing earnings. But you can only run out of cash once. Failures in this area easily lead to everything from the need to turn to emergency credit lines to lost sales and missed opportunities."
The problem, she says, is that at most companies, finance takes full responsibility for working capital, "but truly optimizing receivables, payables and inventory requires a cross-functional effort. And often different parts of the organization may have very conflicting interests, and different priorities and goals that prevent them from achieving their working-capital goals." Working-capital improvement needs to be a strategic objective involving the entire C-suite, Heald recommends, not just the CFO.
Budgeting is Like a Cockroach
Until recently, Holt Cat, a nearly 80-year-old distributor of Caterpillar earth-moving equipment, didn't even do forecasting. As Paul Hensley, vice president and CFO, remembers, "We had 23 straight years of sales growth, and we started to believe that we were invincible and that our growth would be endless."
Then came a wake-up call in the form of the recession of 2009, which forced Holt Cat to formulate a sustainability plan ("sustainability" in the sense of "staying in business"). The sustainability team reacted by reducing headcount by 25%, inventory and the rental fleet by $200 million, and overall expenses by $50 million.
One of the casualties of that process was the budget. "The president and COO didn't want a budget," Hensley says. "We were managing the spend by not giving them a budget to hide behind." Instead, finance set a low, medium and high forecast, but didn't set a formal hard number. "We didn't want a false sense of security."
For Holt Cat, forecasting became a tool for managing the banks and the owner's expectations in an uncertain time. "We set a target [in 2010] to track how we were doing, and we set a forecast to compare to that target," Hensley explains. The result was a 33% increase over 2009 results, while expenses dropped by a full percentage point, which he attributes "at least in part" to not having a formal budget.
Operations managers hated the forecast at first, Hensley points out, because it was scary working without a budget, "but none of them gave back the extra bonus dollars" that they received due to focusing on a target and then exceeding it.
"The budget is like a cockroach," Hensley admits. "It's almost dead, but we have to bring 'Raid' out every once in a while to spray on it" because some managers still regularly ask for a budget, as protection to cover themselves. As he notes, though, "Our desire to grow has helped facilitate the move to a forecast since it is forward-looking, not backward-looking."