Published: October 01, 2014
In this article, Jim Kaitz, CEO of the Association for Financial Professionals (AFP), comments on the Tesco inquiry and outlines the importance of a strong corporate culture, reliable forecasting practices and the integration of corporations’ risk management practices with their financial planning and analysis departments.
After a few successive profit warnings, a plummeting share price, difficulties retaining customers in the current UK supermarket price war and the subsequent departure of its CEO, Tesco recently announced that it had overstated its profits by 23%, or £250m. Following the announcement of this ‘accountancy scandal’, Tesco launched an investigation and suspended five executives, including most recently, its Group Commercial Director.
The £250m shortfall was brought to the attention of the company by a whistle-blower. Allegedly, the retailer was prematurely booking income from supplier deals whilst pushing back costs. According to some sources, these actions were taken to help the retailer to compete with the likes of Aldi and Lidl.
Before this, Tesco had come under major public scrutiny after it was widely published that its CFO stepped down in April 2014, whilst his successor was not due to join until October this year. The retailer admitted on 25 September that between April and October, its CFO had not been involved in any financial decision-making and instead, former CEO Philip Clarke had set up a separate team of financial professionals to manage its finances. Shortly after the overstatement was announced, Tesco’s new CFO joined the company; a month earlier than expected.
While Tesco’s announcement appears to have resulted from an accountancy scandal, even less nefarious situations can cause financial and reputational damages, and cost financial executives their jobs. One major US retailer announced a seven-figure forecasting error that reportedly stemmed from a failure to recognise risks and changing business conditions in one of its business segments. While it is generally accepted that this was a forecasting error and nothing wilful, the financial impact was nonetheless swift and material, as was the retirement of the company’s CFO.
As an expert in financial planning and analysis, AFP recently commented on these issues, claiming that the forecasting error was due to a lack of communication between the company’s financial department and other parts of the company.
Both of these issues are excellent examples of the importance of a strong corporate culture, reliable forecasting practices, and lastly, the integration of corporations’ risk management practices with their financial planning and analysis departments. AFP is a representative organisation for financial and treasury professionals worldwide and recently launched its financial planning and analysis (FP&A) credential, which tests the skills of professionals that are necessary for effective financial planning and analysis.
Culture is often considered to be rather invisible and therefore it can be overlooked by corporate leaders and managers. However, corporate culture should be seen as a control mechanism for financial and operational processes and should therefore be actively managed.
A corporate culture functions as the company’s personality and it can foster operational awareness amongst employees. Sustainable culture models should have a governance structure that includes different employees playing different roles, since the separation of duties helps to gather different inputs and perspectives and provides alignment across the company. A strong model culture will produce better calculations, fewer errors will be made and less time will have to be spent on fixing errors. In addition, the collaboration between team members will increase, which will benefit cross-training and the sharing of institutional knowledge. Therefore, the interaction between finance, financial models and culture can be a differentiator in determining overall competitiveness of companies.[[[PAGE]]]
Besides that, AFP’s recent research on organisational structures in relation to the financial planning and analysis profession shows that a hybrid organisational structure where FP&A professionals are embedded in operations and work directly with line management produces the most reliable forecasting result.
In an ever-changing, unpredictable environment of economic and political turmoil, forecasting has become more essential as well as more complex for companies. The recently published 2014 AFP Risk Survey shows that 86% of respondents claim that they believe their companies will have as much, or even more, difficulty in forecasting critical risks to their businesses over the next three years. Having this in mind, many executives tend to revert to past practices or decide to closely follow their peers in reaction to environmental changes. However, there is a unique opportunity for companies to improve their strategic position and their financial performance if they improve their forecasting practices. This would consequently improve their long-term shareholder value.
If companies want to make the most use of their forecasting practices, they will have to learn how to integrate their risk analysis practices and financial forecasting into the evaluation of strategic opportunities. Although the 2013 AFP Risk Survey showed that financial corporations are not taking enough action to improve their forecasting in this way, in 2014, the AFP Risk Survey showed that financial executives are becoming more proactive. Sixty-five per cent of respondents, for example, claim that they are increasing the focus on risk culture and awareness within their organisations.
Historically, budgeting and planning have been handled separately from Enterprise Risk Management (ERM) and strategic planning processes, but only a few corporations have currently integrated these practices. Amongst these early adopters are pharmaceutical companies and companies in the financial services and energy industries.
It is surprising that only a few companies so far have integrated their ERM and strategic planning processes, since it would create a clear competitive advantage, enabling companies to respond to changes in their competitive environment and shifts in the marketplace quicker and more efficiently.
Based on insights AFP collated in its Guide on Risk-Adjusted Forecasting, there are several reasons why only a rather small number of companies have integrated their financial forecasting and risk assessment practices into the evaluation of strategic opportunities:
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After companies have successfully overcome these barriers and have decided to implement risk-adjusted forecasting, it is to their benefit to start with a pilot, identifying a select few risks to the organisation to then incorporate into the FP&A process. AFP advises FP&A professionals to conduct risk-adjusted forecasting following the steps below:
After these steps have been taken and insights have been collated in a risk-adjusted forecast report, management can begin discussing how to handle if these risks would crystallise.
A strong corporate culture and reliable forecasting practices that are integrated with corporations’ ERM practices will decrease the likelihood of financial scandals such as Tesco, and large forecasting errors recently experienced by others.
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