Business headlines were made last month when the chief financial officer (CFO) of Walgreens, the top pharmacy chain in the US, was forced to resign after a billion dollar forecasting error. More recently, this week brought news that the UK’s biggest supermarket chain, Tesco, was suspending four top executives following a £250m (US$410m) overstatement of its first-half profit guidance.
As all finance professionals know, errors in models are not new and creating an accurate forecast is notoriously difficult. While it is rare to have such a large error made public, it is also unusual for it to lead to reshuffling in the C-suite. A Wall Street Journal article published on August 19 provided some potential insight into other possible underlying causes for the Walgreens CFO’s dismissal:
- “The company’s largest shareholder and a director…told other investors he wasn’t permitted to see the forecasts before they were distributed to the board.”
- In recent meetings, investors say that directors told them “the company’s finance and pharmacy units weren’t talking to each other.”
- In meetings with investors, officials said the company group writing contracts wasn’t communicating with the finance group.
The implication from the WSJ article was that the massive forecasting error at the US chain resulted from a communication breakdown between the financial team and other parts of the company. Communication is a reflection of the larger culture of the company, and the interaction between finance, financial models and culture can be a differentiator in determining overall competitiveness.
The Essence of Company Culture
Culture is often invisible to financial professionals because it is ubiquitous, and many may not think of it as something to be managed. However, culture is bigger than mission statements, codes of conduct and handbooks. It is the company’s personality; it describes how work gets done and is transmitted in the stories told by the team, the processes established and the tone set at the top of the organisation. Seen in this way, culture is a control on financial and operational processes.
Models are ubiquitous tools for financial professionals, who again don’t necessarily regard them as manageable. They are more than just a series of inputs, calculations and outputs; they include best practices that can be developed to make them sustainable over the long term, shareable among teammates, and useful to the business.
Sustainable models have a governance structure that includes different members playing different roles. For example, the team or individuals who build and manage a model should be different from those who validate the assumptions and the calculations. The validators should be technically qualified and have a stake in the outcome, and yet should be independent from the team that assembles it. This kind of separation of duties helps to gather different inputs and perspectives, thereby providing alignment across the company. In the Walgreens episode, it appears the challenge and validation roles were not played by appropriate parties.
Shareable models should be understood across the organisation, built in a way that leverages data sources and assumptions that are consistent with each part of the organisation. In addition, the models should identify the key assumptions to those who are not the model owners and who are not experts in navigating the intricacies of the model. From the forecasting error, it appears that the assumptions were neither aligned across divisions nor apparent to the business unit.
Useful models meet the objectives for which they were designed, and users don’t know whether they have succeeded unless they socialise the results, hear challenges and ensure their customers understand. It is insufficient to build a brilliant model and print the outcome; successful models need to be useful to the business and drive outcomes, and we cannot know that unless our business partners find it effective in driving their decisions and plans.
Managing the processes around models shapes the culture of the company; equally failure to manage it will shape the culture too. A strong model culture will produce better calculations, evidenced by fewer errors and less time to develop and fix errors, and increased collaboration among team members which has benefits in cross-training and sharing institutional knowledge. It can also help the financial professional keep his or her job.
Bryan Lapidus is principal, Clarent Ventures LLC, and a speaker at the Association for Financial Professionals’ (AFP) 2014 annual conference, to be held in Washington DC. Join him for a pre-conference session on financial modelling on November 1, from 8:30 a.m. – 4:30 p.m. Register for the conference here.
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