Feed Forward Forecasting

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Feed Forward Forecasting

• Presented by Oscar S. Lewis

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BiographyOscar S. Lewis

• From Atlanta, GA
• BS University of South Carolina
• MBA Georgia State University
• 15 years in manufacturing positions, primarily in
  pharmaceuticals and medical devices
• 10 years in service and distribution industries

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Oscar S. Lewis Continued

• Instructor University of Phoenix Finance and
  accounting
• Board of Directors Institute of Management
  Accountants
• CBM - APBM

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Feed Forward Forecasting

• Part I
• Key Performance Indicators

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Key Performance Indicators

• Look for what drives your organization
• Sales
• Costs
• Donations if you are a non-profit
• Margins
• Headcount
• Payroll costs

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Key Performance Indicators

• Establish a relationship between a driver and
  performance, good or bad
• Example, if sales are below 1,000,000 per month,
  we lose money
• If we dont collect 500,000 in cash flow, we
  cannot pay our bills and meet payroll
• If our gross margin falls below 30, we lose
  money

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Key Performance Indicators

• You are trying to establish a relationship
  between some indicator and ultimate performance.
• These may not be readily apparent, so look beyond
  your first idea.
• Example, you feel your average sales price is a
  good indicator, until it gives you a false
  result.

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Key performance Indicators

• There may be multiple indicators
• As you focus in on them, they may lead you to
  others that will help you understand your
  organizations drivers better

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Key Performance Indicators

• I started studying this in 1981 when I was Plant
  Controller at a chemical plant for Johnson and
  Johnson
• We were looking for ways to recover if we started
  a month poorly
• While some of this will affect the long-term, we
  are focusing on the short-term to help us reach
  our monthly, quarterly, or annual budgets

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Key Performance Indicators

• Our early ideas were centered around reporting
  requirements
• Even if we closed the books on the 5th working
  day, we had no way of affecting what happened
  during the month
• Knowing how you did in April is useless on May
  5th. You cant impact April unless you act in
  April.

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Key Performance Indicators

• This led us to looking at things on a week to
  week basis
• This was back in the days before desktops tied
  into the company mainframe
• We used spreadsheets (VisiCalc) on an Apple IIC

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Key Performance Indicators

• We had a limited product line
• We knew how many hours we worked in any week
  (line hours, not man hours)
• We knew what we were budgeted to do on the
  production lines
• We knew our actual output
• We sold 100 of what we produced to other JJ
  companies, so inventory wasnt an issue

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Key Performance Indicators

• This led us to whether our three production lines
  were working at efficient rates or not
• If we got production out that corresponded to 100
  hours, and we ran 120, we knew we were behind
• This led us to what we had to do to catch up

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Key Performance Indicators

• At the end of weeks 2 and 3, if we had not caught
  up, we knew we were going to have a bad month
• We also looked at chemical usage
• We had 12 railcars of sodium hydroxide scheduled
  each month. If we got 14 in, we assumed we would
  have a poor usage variance.

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Key Performance Indicators

• This was the same for the other three major
  chemicals we used
• With this simplistic system, we were able to
  focus in on what was happening, and how
  short-term decisions could impact each month
• And we could know how we were doing prior to
  month end so we could try to impact results

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Key Performance Indicators

• This also helped us with the budget/forecasting
  cycle
• In those days, JJ had an annual budget and 4
  forecasts due in a year
• By seeing where we had been, and whether recovery
  was possible, we improved our forecasts
  tremendously over the next three years

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Key Performance Indicators

• I have used a variation on this in almost every
  position I have held since that time
• I will say that in extremely high margin
  businesses, like pharmaceuticals, these are not
  as critical. If your Cost of Sales is 10 and
  your Marketing costs are 35, production
  statistics are not as important as sales
  statistics.

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Feed Forward Forecasting

• Part II
• Choosing the Indicator(s) that are Right for your
  Organization

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Choosing Your Indicator(s)

• What is the best way to go about choosing an
  indicator or indicators?
• Start by looking at broad statistics, such as
  sales or headcount or any other statistic that
  you think can be correlated to performance
• Also choose what performance you are measuring
• For example, profitability is a logical choice,
  but not for non-profits. Perhaps for them its
  fund balance, or programs delivered.

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Choosing Your Indicator(s)

• In this macro level, see if anything is relevant.
  When sales are over 1,000,000, we are
  profitable.
• When our average selling price is above 195.00,
  we are profitable.
• When our gross margin is 30 or more, we are
  profitable.
• When we collect 300,000, in donations, we can
  deliver 200 programs.

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Choosing Your Indicator(s)

• You have defined success as the performance you
  want to measure against
• This is the broadest metric you have its a
  yes/no or black/white number. Were profitable,
  we can deliver programs to our target group, we
  have money in the bank
• I once worked with a vending machine operator who
  wanted to know daily sales and balance in the
  bank. Those were his indicators of success or
  lack of success.

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Choosing Your Indicator(s)

• Once you have a working hypothesis, such as sales
  of 1,000,000 mean were profitable, start
  testing it
• You may find the metric changes over time
• At my company, weve had sales between 6 million
  and 15 million, depending on the state of the
  aerospace market. Right after 9/11/2001, sales
  plummeted.

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Choosing Your Indicator(s)

• Remember, this does not have to be tied to
  revenue
• It has to be tied to what your organization feels
  defines its core success
• Example The two major political parties have
  huge revenue swings, depending upon the election
  cycle. Presidential years are the highest
  revenue years, then the bi-annual elections, like
  for the House. The off-election years have very
  little revenue raised by either party.

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Choosing Your Indicator(s)

• Because of the disparity in annual revenues, the
  parties gauge their success by fund balance
  growth (or shrinkage) and party member growth
• Winter ski resorts in Washington state use a
  simple metric of when the season opens
• If the season opens before Thanksgiving, they
  will be successful. If not, they might have to
  stay open later in the Spring to be successful.

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Choosing Your Indicator(s)

• Golf courses use the number of rounds, although
  private clubs have an advantage over public
  courses because their revenues are dues related,
  not necessarily rounds related
• You are not limited in your choice of indicator.
  Let your imagination roam.

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Feed Forward Forecasting

• Part III
• Using Your Indicator for Short-Term Gain

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Using Your Indicator

• Once you have chosen an indicator or indicators,
  how can you use them to the advantage of your
  organization?
• If your indicator is sales, are there ways to
  increase sales in the short-term, without
  impacting the long-term unfavorably?
• Ultimately, you are looking to work for a
  solution that will help both

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Using Your Indicator

• Organizations have proven that short-term success
  at the expense of the long-term is not a win-win
  situation
• Managing for only short-term results will
  ultimately hurt your organization
• Place the short-term gains in the context of the
  organizations strategic goals

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Using Your Indicator

• Short-term solutions can buy time to find
  long-term solutions, but you cant put off bad
  news indefinitely
• Witness the Germans in WWII when things turned
  against them, they tried short-term solutions,
  but these hastened the long-term problems.
• Enron and WorldCom did the same thing always
  thinking they could find a long-term solution.
  But it eventually became fraudulent when they
  could no longer find short-term solutions.

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Using Your Indicator

• You have to know when your short-term solutions
  are affecting your long-term results
• And you have to have your ethical line in your
  mind well beforehand, so you know you will not
  cross it

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Feed Forward Forecasting

• Part IV
• Practical Examples

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Practical Examples
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Practical Examples
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Practical Examples
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Practical Examples

• Situation
• July is unprofitable. What business metrics have
  changed since April?
• April Sales 1,232,553.34 Units 5,526 Average
  Price 223.05
• June Sales 1,357,656.45 Units 5,313 Average
  Price 255.53
• July Sales 1,074,164.15 Units 5,680 Average
  Price 189.17
• April Profits 115,850
• June Profits 114,929
• July Profits (12,420)
• Obviously, the higher average price helps
  profitability. But Junes was much higher than
  Aprils, and profitability was slightly less.

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Practical Examples

• What else can we look at?
• There are two major business units
• Business Unit 1 has the biggest impact
• April Sales 1,014,028.94 Units 5,443 Average
  Price 186.30
• June Sales 1,123,425.02 Units 5,191 Average
  Price 216.42
• July Sales 880,437.05 Units 5,614 Average
  Price 156.83
• April Profits 66,693
• June Profits 72,180
• July Profits (40,888)

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Practical Examples

• Focusing on Product Family 6
• In April, units comprised 0.04 of sales
  Average selling price 3,725.00
• In June, units comprised 0.44 of sales Average
  selling price 489.19
• In July, units comprised 12.08 of sales
  Average selling price 16.65
• Product families 2 and 4 had large average
  selling price changes, but always remained less
  than 2 of unit sales. Product family 6 had both
  a drop in average selling price, and a large
  percentage increase in unit sales. Product
  family 6 is the major contributor to the problem.

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Practical Examples

• Solution Product family 6 was sold to only two
  customers. Both had it explained to them that
  this was a problem, and we needed to resolve it
  by raising prices. Both customers agreed. We
  have both a short-term and long-term solution.
• The identification of this indicator allowed this
  company to take corrective action that will help
  them meet their objectives. And by monitoring
  these sales on a daily basis, they can spot
  potential problems, analyze them, and hopefully
  resolve them in a timely manner.

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Practical Examples
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Practical Examples
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Practical Examples

• This example shows what you can do when you know
  your indicator
• In this case, the indicator was gross margin
  they wanted it to rise to 30
• They were constrained in several cases, whether
  by having the highest sales price in a certain
  product line, or having a published price list,
  or having to purchase in Canadian dollars.

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Practical Examples

• Rather than try to raise prices across all
  product lines, because that was impossible, they
  addressed the product lines they could raise, and
  also addressed the marketing/advertising of those
  lines.
• They worked to get to the 30.
• Now, they need to monitor dollar sales weekly and
  margins weekly, to see if they are going to be
  successful.

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Practical Examples

• In this companys case, they were successful.
  They didnt worry about expenses below the gross
  margin, per se.
• As long as these were close to budget, the
  profits were generated by the increased margins.
• This company has been following this model since
  2000, and has seen profits rise from 2 to 10,
  on sales and margin growth.

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Conclusion

• Identifying the metric that best defines your
  organization
• Find what impacts this metric
• Start monitoring your weekly progress towards
  meeting this metric
• If you are falling short, identify short-term
  solutions that will get you back on track
• If you cant get back on track this period, can
  you get back before quarter or year end?
• If not, adjust your forecast
• Dont fail to report potential problems to senior
  management. Many work on the basis of no
  surprises