AiroAV Announced Top 12 Audit CPA Exam Tips - Jonathan Cartu CPA Accounting Firm - Tax Accountants
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AiroAV Announced Top 12 Audit CPA Exam Tips

Top 12 Audit CPA Exam Tips

AiroAV Announced Top 12 Audit CPA Exam Tips

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  string(53) "The 3 Most Common Forecasting Errors Retail CFOs Make"
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Smart investment on the planning side can help retailers better align forecasts with actual sales.

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Last year was a tough one for Barneys. The luxury retailer shuttered 15 of its 22 stores and turned the 2019 holiday season into a fire sale as it prepared to close its signature store in Manhattan. Other major retailers struggled, too, with at least 16 of them filing for Chapter 11 bankruptcy. 

The rise of online sales, now more than 11% of commerce in the Unites States, is a factor, and so are tariffs. Some of last year’s most popular goods, including electronics, shoes, and hats, were affected by the trade standoff with China.  

But retailers have done themselves no favors by missing the mark on the forecasting side. The stock price of Macy's, the largest department store company in the U.S., plunged 13% to a 9-year low of $15.82 in the second quarter of last year in part because of weak forecasting.

"A fashion miss in our key women's sportswear private brands [and] slow sell-through of warm weather apparel" forced the company to take markdowns to clear excess inventory, said Jeff Gennette, the company's chairman and CEO.

Anticipating demand is always a guessing game, but many retailers make unforced errors by clinging to inadequate forecasting processes, financial planning and analysis (FP&A) consultants told CFO Dive. 

"Retail forecasting is a little bit of science and a little bit of art," Carlos Castelán, founder and managing director of retail consultant the Navio Group, told CFO Dive. "We think of sales as an outcome of the transaction but there are a lot of steps ahead of that. Having a sense of, more broadly, the larger sales funnel can greatly improve your forecasting."

Here are three common forecasting mistakes retailers are making.

Running into the Forecasting Wall

Many retailers think they're engaging in dynamic forecasting when they build in a way to make updates throughout the year, but in reality their process is static, FP&A consultants say, because what makes forecasts dynamic isn't the updating process, but the time horizon.

"One of the common mistakes CFOs are making is what we call forecasting to the wall," Steve Player, managing director of the Player Group, told CFO Dive. "Large companies will many times prepare a forecast, but if you look at what they’re really doing, they’re preparing a descending forecast.

A descending forecast, or what planning specialists call forecasting to the wall, is when CFOs create a six-, 12- or 18-month plan and make subsequent updates as new data come in, but the time horizon remains unchanged. 

In a common scenario, the CFO will create a 12-month forecast starting in January, make quarterly updates, and leave the time horizon fixed at December 31. As a result, the company forecasts for shorter and shorter increments. 

"The first one is 12 months, the second's nine months, the third is six months and the fourth one's three months and then they pop out another year," said Player. "All they're really doing in that kind of situation is updating their projection to validate their budget target."

A better approach is to use a rolling forecast, in which the time horizon gets pushed out by the same number of weeks or months as the update. If you're using a 12-month forecast, in addition to updating your estimates every month or every quarter with new data, you push out the time horizon by another month or another quarter and remove the corresponding trailing time period. That way, the forecast remains 12 months, but you never reach the endpoint, or wall.  

Brian Kalish, an FP&A consultant whose clients include retail companies, said the rolling time horizon enables executives to make decisions based on market dynamics rather than an artificial target. 

"If your sales compensation is based on hitting your numbers for December 31, your behavior will be very different than if you're ignoring that deadline," Kalish told CFO Dive. "The business is going to exist on January 1, so what happens is, you start making economically suboptimal decisions to hit artificial targets."

For the past year, Kalish has been helping a spirits company move from a static to a rolling forecast to regain sales it was losing because of chronic inventory shortages. 

"They were basically looking over what had happened the last 12 months, [made] a best-guess growth estimate, and assumed that's how they were going to do it," Kalish said. "And it wasn’t bad. But the problem was stock-out. All of a sudden, orders were coming in and they just couldn't fill them as efficiently."

By going to a rolling forecast, he said, "it gave them a much better idea, not only because they could see their internal information, but because we structured it so they could start bringing third-party information in there. All of a sudden, you can start seeing ramp-up."

Conflicts of Interest

Whether you're doing static or rolling forecasts, unless you change the incentive structure in your annual budgeting process, you're almost guaranteeing inaccuracy in inventory levels, and by extension sales, consultants say. This is because most incentive structures are built around sales targets, not accuracy. 

"Budgets are a little bit of a negotiation process," Karen Sedatole, professor of accounting at Emory University, told CFO Dive.

"The sales team negotiates lower budgets than what they think they can meet, because they want to make sure they meet that budget by the end of the year because they want to get their bonus. If I think I can sell 100 units, when I'm negotiating my budget targets with people higher up in the organization, I negotiate a target of 90, because I think I can sell 100. That way I make sure I meet my budget by the end of the year."

Player calls this practice a monstrous conflict of interest because it virtually guarantees sales estimates will be low-balled in the initial forecast. 

"The budget manager's not going to negotiate stretch goals or outstanding performance because he's going to be judged against that — and his bonus is going to be based on that —  so now his incentive is to give a sandbag budget, with minimal acceptable returns," he said. "If you're designing an internal control system, the first thing you try to avoid are conflicts of interest, and here the budget puts one right in the middle of its mechanism."

This sandbagging is a recipe for inventory shortages, and therefore lost sales, because once the budget's approved and the forecast set for the coming year, production planners set in motion a process for producing an inadequate...


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