“Forecasting is a not finance-driven process”

by Sathya Kalyanasundaram    Mar 05, 2012

Sathya KalyanasundaramIt is a tool that helps in risk management to mitigate the effect of uncertainty in business outcomes, writes Sathya Kalyanasundaram.

Nassim Nicholas Taleb, author of the best seller “The Black Swan”, a book on unpredictable events, famously remarked that things always become obvious after the fact. This is a simple statement; however, a very powerful one. It is always easy to see events clearly in hindsight and the reasons for their occurrence become apparent after the event has actually occurred. To predict an event and prepare for its outcome requires a totally different approach.

Here’s where forecasting, ingrained into the very fabric of today’s dynamic environment, comes in. Effective forecasting offers the powerful advantage of helping manage business via a front-view versus a rear-view approach.

Predicting business performance

Forecasting can be defined as a process of compiling information from individuals, managers, business units, product lines and any other contributor to the overall business performance; and assimilating the compiled information into a model that offers the ability to predict the resulting business performance.

The process of compiling the information varies significantly depending on the organization, the corporate culture, the cycle of forecasting (monthly, quarterly etc.), the review process (forecast vs. actual), to name a few important factors.

This step also includes the provision of assumptions and probabilities for the compiled inputs. Leaders may take calls to attach probabilities to the occurrence of the inputs; either wholly or partly. These calls or judgments, in turn, result in forecasting assumptions that are baked into the inputs and the forecasting model itself.

For example, a manager who is planning to add a certain headcount within the organization in the subsequent periods will solicit the team’s performance in meeting the headcount forecasts and the targets that were projected for prior periods. The manager can then choose to adjust or retain the forecast for headcount addition based on prior performance, current market conditions for the talent pool sourced, etc.

The next step in the forecasting process involves the consolidation of the forecasts at each level of decision making. It is important to do this necessary step since decision making at the right level at the right time is very often the key to success in business.

Many a turmoil in business has been due to the result of ineffective or no forecasting at the decision making levels such as a product line or a specific support organization.

The last step in this process is the roll up of the consolidated forecasts into the overall business performance forecast of the organization. This process is generally conducted by the leadership of the organization who then apply many scenario-based planning mechanisms in tweaking the forecasts and slicing the parameters in multiple versions to help predict resulting business performance.

Publicly traded businesses have the responsibility of providing forecasts and guidance of business performance on a regular (mostly quarterly) basis to statutory bodies, investors and the general public. The forecasting process in these organizations tends to be extremely robust.

Successful organizations are always able to predict, not only their business performance, but the overall trend of the markets that they operate in general. This is possible only by a very granular level of understanding of historical data, the structural changes if any, to the ecosystem within which they operate, and the emerging trends in the markets that they operate in.

It is argued by many that the forecasting process itself is the benefit of forecasting and is extremely valuable since it requires leaders to comprehend the inherent dynamic nature of today’s business and thus requires them to prepare for the same.

Reaping the benefits of forecasting

The applicability of effective forecasting is universal. It is a common misnomer that forecasting is a finance-driven process since it is very closely linked with the budgeting and financial reporting functions that form the core of finance. However, forecasting is a tool that can be used for any indicator of business performance, more so if the specific indicator has the ability to be measured. In today’s world where the demand and supply of goods happens at an increasingly lightning speed, some of the most important forecasts are centered around supply chain and inventory management.

Ensuring that the right product is at the right place at the right time can define the success or failure of any business.

Forecasting as a tool helps in the all-important role of risk management, to mitigate the effect of uncertainty in business outcomes. Many organizations have resorted to a more risk-based forecasting process in the light of the significant downturn in business conditions in 2009.

A number of scenario-based plans are being drawn today with the induction of many stress tests around product lines and business operations to enable business to react quickly and effectively to changes in market conditions. Moreover, many of these scenarios are being integrated to cover many forms of risk such as financial, political, technology and so on.

(The author is Finance and Operations Director at Texas Instruments)