Deloitte Talks About Risk-adjusted Forecasting and Planning

Norman Marks, CRMA, CPA, was a chief audit executive and chief risk officer at major global corporations for more than 20 years. The views expressed in this blog are his personal views and may not represent those of The IIA.

 

A recent Risk Angles issue from Deloitte, Five Questions on Risk-adjusted Forecasting and Planning, caught my eye as I have been a strong advocate of such methods for many years.   

The principle is that every forecast or business plan is uncertain. When a CFO presents the latest forecast for the year or quarter, he will typically provide a single number for each line in the forecast, from revenue to the bottom line. But this is his selected projection (a best guess) from among a range of options. If asked, he may say that he is 79%-80% confident in the forecast, but that is based on estimates and assumptions.

Risk-adjusted forecasting and planning recognizes that there is a range of possible results. Not only are there estimates, which may be clearly expressed as such, but assumptions are made. If an organization is to optimize performance, it needs to understand this uncertainty, factor it into the forecast, and take action to increase the likelihood of positive events (such as a potential sale being realized) and minimize the likelihood of negative events (such as delays in a supplier’s delivery of critical components).

The Deloitte perspective is focused on understanding the risks that might affect future performance and factoring that into the projection. Understanding the risks and factoring them into the plan should improve its accuracy (the likelihood of it being correct), and demonstrate to the board and the organization’s executive leadership an appreciation of risks to performance. Deloitte suggests presenting the forecast as a range of potential outcomes, each with an estimated likelihood of occurring.

The Risk Angles piece is a start and more can be found in other pieces from Deloitte:  

While this is good, it doesn’t go far enough for me. I believe that understanding the risks and the how they affect the likelihood of different outcomes is a start. But the key is taking action to improve the likelihood of and potential effect of positive events and minimize the likelihood and effect of negative events.

If I were CFO, I would present the risk-adjusted forecast as a range of potential outcomes, with estimated likelihood, and the actions that are necessary to optimize the results.

As CRO, I would seek to help the CFO in this initiative. I welcome your views and comments.

Posted on Sep 9, 2013 by Norman Marks

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  1.  

    Dear Norman,
    Thank you for sharing this article with us. Risk adjusted forecasting and planning is effectively a good tool to visualize the cumulated effect of uncertainties on the profitability and how the planned mitigations can reduce the spread of future outcomes. However it still requires a lot of judgment to translate the effects and the inter-connections of the potential events into a model, without making it too complicated. It also requires a good understanding by the decision-takers (C-suite and Board), how do they really understand 90% of confidence, 90% of chance to achieve the targets or go beyond.
    It can also be used for project approvals or long term contracts.
    However it doesn’t avoid to do a segmentation of the risks as all losses are not equivalent, depending on their causes (mismanagement versus external risk factors)
    I would also be interested to see if there are internal auditors who are using it to report the consequences of unmitigated risks to the Board.
  1. Norman, I have posted this reply on the Deloitte web.'As a scientist turned accountant, I have always been wary of any figures quoted to an unrealistic degree of accuracy, usually because they have been derived from a formula in a spreadsheet. So, for example, sales forecasts are quoted as '$14,429,000 for the next 12 months'. An accuracy of 1in 15,000! No company could estimate the current month's sales to that accuracy. The problem is that the 'C-suite' won't normally accept forecasts like '$15m plus or minus $2m' as it looks like a guess. However, I believe that there are other questions that must be asked, 'what decisions do I want to make?', 'what information do I need to make these decisions?', 'how accurate do I require this information to be?' The article doesn't mention financial modelling (although the poll at the end does), such as @RISK, which I believe should be used for any major expenditure decision.' David Griffiths

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