You missed your numbers. Now what?

By now, you should know where you stand relative to your 2013 budget. Hopefully, you made it or beat it. For some, the finally tally will show a “miss to the downside”. When i say miss, I’m referring to performance against the original budget – the one you put together in December 2012. Performance against the 2013 re-forecast you prepared mid-year (hopefully not multiple times throughout the year), isa separate matter. The fact that you had to re-forecast because of  downside miss is a signal in and of itself.

So, you missed; now what? The first thing you should do is ask yourself: Why?

There are too many reasons companies miss plan to list in one blog post. Some are legit; many err on the side of “excuses”. I think it is important to attribute misses to reasons over which management had some measure of control. If you can’t control it, you can’t make a change in your execution strategy that adjusts for it. All the other “reasons” are interesting, but aren’t particularly useful, with the exception of black-swan style macroeconomic shocks, which aren’t excuses but are facts of life.  To simplify, I break down reasons for missing plan into two categories – forecasting error and execution error.

Forecasting error

A budget is a forecast with a lot of moving parts. Sales productivity, unit prices, churn, cost of goods, sales and marketing expenses, headcount, compensation levels, the list goes on. I think it is a good discipline review your budget and determine which specific assumptions (if any) are at variance with actual performance. Forecasting error will show itself when there is an assumption in the budget that is at variance with actual performance, management could not have know that the forecast was wrong and the error can’t be attributed to execution error. For example, the fact that your sales reps produced 50% of the bookings per rep that you budgeted is more likely execution error than forecast error, particularly if you had good reason for setting the forecast at the chosen level. Some might argue that forecasting error isn’t within a management team’s control, to which I’d respond:

If management didn’t prepare the budget, who did?

Forecasts are entirely within management’s control. No-one knows more about the assumptions that go into building a budget than the management team that is steeped in the business. That said, a company’s performance against a budget may be affected by factors beyond management’s control, however, that type of miss is probably a different type of error. Forecasting error will happen at a higher rate in earlier stage businesses or businesses where a new management team has been brought in. In both cases, the process of developing the drivers for a forecast/budget may not have the benefit of significant historical data. In the absence of historical data, forecasting is a process of making informed guesses, many of which may turn out to be wrong.

Forecasting error also occurs when a management team “misses” a plan to the upside. This type of forecasting error is forgivable, but is equally important to correct over time.

Execution error

The alternative to forecasting error is execution error. By default, no matter the stage of your business, you should suspect execution error before forecasting error for any miss, unless you can prove to yourself beyond a shadow of a doubt that you executed well. Execution error takes many forms, all of which require corrective action. Where execution error is present, it is critical for a management team to be honest with themselves and to take corrective action. 

Differentiating between forecasting error and execution error?

You know it is forecasting error if:

  • There was little to no historical data to back up an assumption in the forecast;
  • You made efforts during the year to improve performance against the assumption, but without success; and
  • The miss can’t be attributed to execution error.

You know it is execution error if:

  • There was good historical data or sound reasoning to back up the assumption in the forecast, but you missed anyway;
  • Efforts to improve performance against the assumption had a positive impact during the year, execution improvements made an impact; and
  • Team members responsible for performance against the assumption are viewed as under-performing.

Is one worse than the other?

For me the answer is yes. I’m much more forgiving of forecasting error than I am execution error. The caveat being that, over time, management teams should be able to increase their forecasting accuracy (reduce forecasting error) with the accumulation of experience, knowledge and data about the dynamics of their company. Management teams that are unable to close the gap between forecast performance and actual performance over time aren’t learning and forecasting error and execution error become indistinguishable.

Derek Pilling is a Managing Director at Meritage Funds, a growth equity firm. Derek invests in technology-enabled services businesses in the Internet Infrastructure, Cloud Computing, Digital Media and SaaS sectors.Derek lives in Denver with his wife and his three children. In his spare time, Derek enjoys coaching youth soccer, skiing, hiking, spinning and hopping on his rowing machine in the morning.

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Derek Pilling

About Derek

I'm a Managing Director with Meritage Funds, a growth equity investment firm based in Denver, CO. I've been working with growth stage businesses my entire career. When I'm not working, I ski, spin, coach youth sports and spend time with my beautiful wife and three kids.

I blog because the process helps me crystalize how I frame the world. I want to hear what you think. Please comment.

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