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Share price going down: The real cost of poor forecasting

February 8, 2008

Editor's note: The following is based on the recently released report, Forecasting with confidence: Insights from leading finance functions, published by KPMG.¹

According to the findings of a recent global survey commissioned by KPMG, poor forecasting costs – on average – six percent of a company's share price when analysts and investors react to a significant mismatch between outlook guidance (based on company forecasts) and actual results.

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In today's increasingly uncertain business environment, effective forecasting becomes even more vital.

Pressure from the credit crunch

The recent credit crunch and uncertainty about the impact of the fallout from the U.S. subprime mortgage crisis have increased pressure on all listed companies, putting them under immense pressure to inform the market of losses and quantify, where possible, the level of future uncertainty.

Put simply, poor forecasting costs money and jeopardizes investor and shareholder trust and limits business performance.

The market abhors a vacuum, so where guidance is not forthcoming it is making its own assumptions.

A renewed focus on the process

The credit crunch has also renewed the focus of analysts, regulators and the market on the robustness and quality of scenario analysis performed as part of the forecasting process.

There is a very simple explanation as to why companies are generally poor at forecasting. It is because they do not treat it seriously enough, seeing it as an art rather than a science. In fact it is a science – and failure to accept this can hit businesses hard.

Good forecasters enjoy better performance

Executives in our survey estimated that poor forecasting can be equated to share price losses of around six percent over the last three years.

However, the real impact goes deeper than that. Accurate forecasting is at the heart of any performance management process as it provides the reliable foundations on which heavyweight strategic decisions can be made.

Companies that were “good” forecasters (i.e. which kept inaccuracies below the five percent mark) saw their share prices rise by 46 percent, over a third more than other, poorer forecasters who achieved a rise of 34 percent over a three-year period.

Technology only part of the fix

When looking for solutions to forecasting issues many finance directors or CFOs turn to technology.

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Rolling forecasts

Across the survey, over one-third of organizations identified their existing technology as a barrier to effective forecasting.

Nearly all organizations questioned in the survey still relied on spreadsheets as part of the forecasting process with a worrying 40 percent relying solely on spreadsheets.

The best way to maximize return on investment in technology is when it is part of a wider finance transformation program.

Simply implementing new technology within the forecasting process will not solve wider underlying data and process issues.

Forecasting to drive culture change

Forecasting needs to become a tool that is used to facilitate a process of change between the finance function and business heads within the organization.

Improving the frequency of forecasting to monthly rolling forecasts with full reviews quarterly will help to embed the process within organizations, especially if the discipline is also maintained to explain actual performance against forecast, both for over and under performance.

Find Out More Discover best forecasting practices at Cognos Virtual Finance Forum 2008 Read the related story, "Six rules for effective forecasting" Four simple steps to better forecasts

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Sources

¹ KPMG International commissioned the Economist Intelligence Unit to write Forecasting with confidence: Insights from leading finance functions. The report is based on a global survey of over 540 senior executives involved in the forecasting process, including 168 CFOs from a cross-section of industries .Fifty-nine percent of respondents were from organizations with over U.S. $1 billion in annual revenues and were drawn from a cross-section of industrires. Survey results were supplemented by interviews with senior executives, academics, and experts in the field.