Occasionally we will see boards or leadership teams surprised because the financial performance of their organization is not matching the projections adopted in the plan/budget for the year. Because they have not peeled below the projections to understand the assumptions behind them, they don’t know how to fix the problem. “What did we miss and why? Is it marketplace changes we couldn’t control or foresee? Is it a change in our competitive status in our markets, i.e. losing market share? Is it poor execution by the management team?”
The challenge here is that projections of how the company will perform are only as good as the assumptions behind them. What will be our sales? What will be our costs? Did management assume that trends from recent years will continue? Was there any serious analysis of competitive factors that could make the future different and impact the company? Leadership needs to assess if there are new competitors moving into the market, if government contracts are drying up, etc. Failing to see competitive or political threats can result in continuing your current level of costs without the revenue to cover them, with the result that you experience losses.
Here are some steps on what both boards and management can do to minimize the risk of relying on projections that are not based on sound assumptions:
- The primary step we recommend is for management to undertake a serious strategic analysis using tools such as Michael Porter’s “Five Competitive Forces” or similar analysis in order to understand changes in the environment, evaluate their impact and more appropriately plan the organization’s strategies for the future.
- Management can routinely examine how the organization compares with peers in the industry on such factors as costs of production, overhead, productivity, etc. Get a sense of your status vs the industry leader, what the plans are to “catch” that leader, and what other competitors including the leader are doing to secure even more market share.
- The board can consider bringing in an industry expert to either educate them on current trends or to participate as an outside board member who can critically evaluate the assumptions in management’s projections.
- Both the board and management can assess the risks associated with the financial projections/budget of the organization. Is the budget based on conservative, middle of the road or optimistic projections?
There is an upside to securing on a clearer understanding of the assumptions impacting your bottom line financials. Conducting an environmental analysis in order to more accurately forecast financial projections will reveal threats from your competitors, dwindling government contracts, etc. However, a good analysis will also surface solid opportunities to grow the organization and to benefit from a changing environment. If you have been surprised by poor performance based on a shallow analysis that missed some real threats, chances are you may be missing some equally real opportunities.
For more information on assessing your financial projections or on conducting a state-of-the-art strategic analysis in your organization, contact us.