The Impact of Forecasting on Return on Shareholders's Value

High level executives are more concerned with the impact of forecast accuracy on shareholder value than on forecast accuracy per se ... shows by how much a company increased its shareholder value by improving the forecast accuracy ... describes steps the forecaster should take before making a proposal to upper management for imple-menting a forecasting system or revising the existing one. Few C-Level executives (CEO, COO, CFO, etc.) care about forecasting accuracy. What they care about is the impact of improved forecasting accuracy on shareholder value. In this paper, we present a of the impact of improved forecasting accuracy on shareholder value and how improvement in forecasting accuracy in one company improved its shareholder value. No company was ever successful simply from more accurate demand forecasting. Unless these more accurate forecasts can be translated into higher levels of customer service and lower supply chain costs, the impact of improved forecasting accuracy is lost on corporate profitability. By the same token, C-level executives are not interested in investing corporate dollars to improve forecasting performance unless it can be translated into higher return for the shareholders. After all, return on shareholder value is the primary concern of upper management. Although improved forecasting accuracy often has a profound impact upon corporate profit and shareholder value, it is seldom presented as such to upper management. Given this reality of business management, what is the most effective way to demonstrate the impact of improved demand forecasting performance? The answer lies in the translation of forecasting accuracy into improved operational plans and execution and improved service to customers. The former results in lower costs per dollar of sales, and the latter results in increased sales. A MODEL OF RETURN ON SHAREHOLDER VALUE The improvement in shareholder value resulting from improvement in forecasting accuracy can be visualized with the help of the famous Pont model of financial performance. The Du Pont Model is a framework for viewing the impact of changes in sales, capital, and operating expenses on return on net assets. A slight revision in this gives us a return on shareholder value (See Figure 1). In this model, we start with sales revenue and subtract from it all the costs of doing business. Notice this is not a gross margin calculation, where only the costs of goods sold are subtracted from sales revenue, but rather all costs (fixed and variable) are subtracted to give us the profitability of the business unit. In the lower right part of the model, we examine the total investment by shareholders in capital, both working (primarily accounts receivable and inventory) and fixed. Ordinarily, to this is added retained earnings of the company to arrive at shareholder value. However, retained earnings is a financial decision by the Board of Directors and the shareholders whether to leave money not invested in capital in the company or take it out. Further, since we are solely concerned here with the impact of operations decisions on shareholder value, retained earnings is irrelevant and, thus, left out of the decision in Figure 1. Dividing profit by shareholder value (capital investment) gives us a return on shareholder value. This is a primary factor for any decision made by chief executive officers, chief operating officers, chief financial officers and, in fact, any executive in the business unit. AN ACTUAL EXAMPLE Figure 2 illustrates an actual example of how improved forecasting performance impacts shareholder value. Although the numbers have been slightly altered to protect the identity of the example company, this company originally had sales revenue of $2,000,000,000 and total costs of $1,900,000,000 (annual profit of $ 100,000,000), on a working capital base of $200,000,000. …