David Carter’s guide to forecasting: avoid

It is rare that I read something that is so nonsensical as to be misleading but David Carter’s guide to forecasting and budgeting is plain wrong on multiple levels. But let’s start with what he gets at least half right. In reference to forecasting:

This specialist task is more concerned with data collection and is an area where Microsoft Excel – the most commonly used tool – is inadequate for forecasting and budgeting.

Excel should never ever be used for this work. But to relegate the financial role to one of data collection downplays the importance that professionals play in testing assumptions, clarifiying logic and assessing the cohesive sense of a company forecast. The ability to provide a strong yet reasoned critique of a forecast is a crucial, senior role. Anything less is simply not doing the job. Now for the statement with which I most strongly disagree:

Past totals, past transactions and business drivers can all be used as the basis for forecasts, but if the forecast is not derived from past or present data, it is simply a guess.

This is utter hogwash. If this analysis is correct then how do you forecast for a startup? What about macro-economic events? How about acquisitions or disposals? What about legislative impacts? The list goes on but you get my drift. David then goes on to succeed in confusing himself:

Different elements of forecasting seem to be mutually contradictory. Forecasting is the process of speculatively reviewing the financial effects of any number of possible future business scenarios; budgeting is the process of determining and subsequently reviewing expected income and costs over a period of time, based on the particular business scenario that has been adopted by the management of a business as being most in accordance with its actual expectations for that period.

Forecasting and budgeting are not mutually contradictory – they are entirely separate but related disciplines. Here are my definitions:

• A financial forecast is a prediction of inputs and outputs based upon the strategic plans a company has in place as measured over a given period of time.
• A budget is the process of identifying, gathering, summarizing, and communicating financial and non financial information about an organization’s future activities, most often based upon its strategic plans and forecasts for income but not so often for expenditures.

In advanced companies both forecasts and budgets are adjusted on a rolling basis as new events and circumstances emerge. Where they differ is in the negotiated elements that usually apply to spend categories. This is a topic that I constantly butt against when negotiating client work.

Budgeted expenses can and often do feed into forecasts but not necessarily the other way around. You can argue whether Carter’s use of the term ’speculative’ implies a sense of gambling but on all the forecasting situations I ever contemplated, the last thing we were doing was speculating. Instead, we were orchestrating a plethora of variables, some with greater probabilities of accuracy than others. That’s not the same thing but requires a level of rigor that Carter seems to deny.

The best clue to Mr Carter’s confusion though lies in his brief synopsis of six products he claims to have reviewed. In regard to COA Collaborative Planning, he says:

Attractive web-based package that gets the whole budgeting process under control.

Compare this with the company’s own blurbs on the topic:

Collaborative Planning – offers a unique solution for both the creation and subsequent monitoring of financial plans and forecasts across all business sectors. By enabling collaboration, the key financial processes of budgeting and forecasting are optimised and timescales and costs are significantly reduced. It introduces real-time, continuous planning and analysis in a single, web-based system.

In fairness, I don’t think Carter is helped by the somewhat misleading names applied to products. Inca Planning for instance is a catch all product with a greater emphasis on budgeting with some reporting attached.

And why did the report omit the most important players: Hyperion now owned by Oracle and BusinessObjects/Pilot, now owned by SAP? More important, why doesn’t Carter talk about the conceptual differences in a more lucid manner, pointing up the necessity to document assumptions and models?

The tragedy is that the guide is going out under the auspices of ICAEW’s IT Faculty. Surely they should know better.

For a more straightforward explanation of some of the forecasting pitfalls, I recommend taking a peek at Microsoft’s basic advice on the Excel pages. Those that want to take a more comprehensive view might wish to dip into the BusinessObjects community.

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Tagged as: Budget, ICAEW, Microsoft Excel, SAP AG