Do you forecast optimistically?

Forecasting is not an exact science. Former veteran weather forecaster Michael Fish learned this to his detriment in 1987, when he failed to predict a hurricane was hours away from wreaking havoc in south-east England.

Where finance is concerned, it is an art that can be honest, dishonest and numerous variations in between.

Andrew Thewlis, finance director of food and drink wholesale buying group Unitas Wholesale, says forecasting boils down to interpretation of data.

“Fundamentally, honesty is the best policy, but honesty is interpreted in different ways by different people,” he says.

Most FDs and CFOs are truthful, he points out – it is just a question of how much of the truth they share. “That’s where the interpretation comes in,” Thewlis explains. “You have to make a set of forecasts based on a set of assumptions and those forecasts are true in relation to those assumptions. But how accurate are the assumptions?”

Thewlis’s approach is to talk to everyone involved in the specific areas of the business he is scrutinising. “You don’t make up your own stories or come to your own conclusions without talking to people that are closer to the coalface.

“And then you overlay your understanding of the finances onto the assumptions that other people might have and you might interpret those assumptions.”

Part of the FD’s and CFO’s skillset is to detect bullsh*t when they hear it, he says, especially when talking with salesmen. “That is the role of the FD – to bring some prudence and reality to what other people are usually over-optimistically assuming is going to happen on the forecasting front. It’s just a reality check.”

Give an over-optimistic forecast today and you might be popular with the board for a limited time. But wildly overegging the cake could come back to bite three months later. Directors will also lose trust in what the FD or CFO says.

“If you are overprudent and overcautious – and I probably do fall into that camp – the board can build in their own expectations once they get used to the FD’s approach,” he says. While Thewlis would like to be 100% accurate in everything he says, he would much rather take 5% off and have that nice surprise when reality kicks in.

Nick Levine, head of enterprise at ICAEW, says honesty is the right overarching approach for financial professionals and, if they feel the information being provided by various departments does not ring true, it should be beholden on them to question those individuals.

“If those individuals still hold that view, that’s fine, but at least they have asked the questions,” he says.

Levine acknowledges that punchy forecast briefings – especially where there are sales teams involved – can help people focus on a particular goal and get them working towards it.

Motivating people to go out and achieve more is a good thing, he points out, but it is also important that forecasts are achievable.

“There is a fine balance between overforecasting and encouragement. You’ve got to look at the business circumstances,” he explains.

“If you have a forecast that is more optimistic you might want to also have another forecast, or a series of forecasts, based on different circumstances or variance analysis.”

That way, if the worst-case scenario was to transpire, you are forewarned that it might be necessary to take out a loan or raise equity. “These are issues you need to be thinking about,” Levine says.

Andrew Hicks, CFO at British software and services company Advanced, agrees.

“CFOs are integral to formulating strategy, driving growth and guiding decisions, which means accurate versions of the truth and growth projections are essential,” says Hicks.

That does not mean that best-case scenario forecasts based on potential growth strategies cannot be put forward, he says, so long as these are transparent.

“This is arguably more optimistic but, in turn, allows the rest of the business to have their expectations appropriately managed while maintaining a reputation for having good judgement that is based on facts.”

Hicks says the CFO’s role is ultimately to deliver the maximum valuation of their business and interpret numbers in real time from across the organisation – and ensure there is no room for misinterpretation or manipulation.

Distilling these figures into “one single version of the truth” is essential for strategy forecasts and actual growth – as is having the right technology to make this complex task as simple as possible.

“It’s these honest and optimistic CFOs who can challenge the business and drive financial models that maximise growth that will earn the greatest respect, trust and reputation as a spearhead leader of the organisation and board.”

Following a successful career as a retail and ecommerce analyst, working for companies including Goldman Sachs, Panmure Gordon and Poundland, Philip Dorgan established his own investor relations’ advisory service in 2018.

“There are lots of things happening that could go right or wrong – lots of moving parts in any company and you have to try and manage expectations and manage your own growth profiles,” says Dorgan. “If you forecast 20% growth and then there’s 25% growth, that’s good. There’s no point forecasting 30% growth because you want to hold something back for a rainy day.”

Thewlis says forecasts end in tears when FDs and CFOs do not explain their assumptions. “You might be 100% accurate this time but you’ve got to get into a habit of explaining how the forecasts have been built. Not to the point of putting everyone to sleep – you’ve got to make it understandable to non-financial people.”

That’s where they can go wrong, he explains. You can’t just assume that board members have read and understood a forecast, and there are no questions because they fully endorse it. ”The odd question just helps you realise whether they’ve understood it or not,” he advises.

The key is not to work in isolation, says Thewlis, because anybody can crunch numbers. ”Actually connecting it to reality and what’s going on in the business is key, and talking to the people who actually do the work because they should know better than you,” he says.

Rick Smith, managing director of Forbes Burton, which has worked with numerous financial directors and management team members to help grow business, says: “Honesty is always the best policy for financial directors. The most recent case of Patisserie Valerie is testament to this approach and highlights how an allegedly dishonest approach can cause potential problems to snowball.”

It is understandable that an FD will want to remain in favour with the company’s board of directors. However, Smith says honesty should form an integral part of an FD’s ethos, ensuring ethical practices are consistently maintained.

“If impropriety is later discovered, popularity is likely to take a dive and trust is often hard to retain.”

It is also important to remember there is a big difference between optimistic forecasting and being disingenuous, he warns. “A financial director can present an optimistic forecast as long as there are facts and statistics to back up the figures. However, it is also advisable to offer an alternative scenario to the board – presenting information that covers all aspects and outcomes to the board will help maintain integrity and creditability.”

Vickie Brown has been finance director at Distinction Doors in Tankersley, South Yorkshire, since August 2014.

The company, which supplies more than 7,000 glass reinforced plastic composite doors every week, made a pre-tax profit of £1.4m on £40.6m turnover in the year to the end of December 2017.

Brown says it is important that FDs and CFOs understand the context of the forecast, who the audience is – whether internal or external – and their risk strategy. “For example, it would be appropriate for an owner-managed SME who is very reliant on cash flow to produce a worst-case-scenario forecast that can then be used to mitigate any potential cash constraints in advance,” she says.

In contrast, a board looking for inward investment might be more keen to put together a more optimistic outlook.

She says the one thing she can guarantee with a budget is that the actual result will be different. “As long as you understand and can explain the reasons why the actual performance is different, that should be acceptable.”

However, she adds that without buy-in from the senior leadership team and management team it is highly unlikely that the forecasted result will be achieved.

“If you have buy-in to the forecast, and you are able to ensure that people remain accountable throughout the year, you have a much better chance of success.”

Brown warns against FDs and CFOs allowing themselves to be manipulated into producing a forecast that gives a certain result. “Don’t allow yourself to be convinced to create a forecast that you think is unachievable just to keep stakeholders temporarily satisfied.”

• Do you forecast optimistically?
  Business & Management Magazine, Issue 271, February 2019

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