Saturday, July 19, 2008

What do You Forecast?

This question might seem trivial. For sales executives working for public companies and selling complex solutions, the answer is however far from harmless. It can actually significantly impact those executives' tenure. One might even argue that confusion about this answer could be one of the reasons for the fact that the tenure of Chief Sales Officers (CSO) is the shortest among all CxOs of a corporation.

The financial markets, represented by financial analysts, are the most demanding and unforgiving constituency when it comes to accuracy of the top line forecast of corporations who's stock is publicly traded . It is thus essential to know how financial analysts define the top line forecast? For them, top line forecast means the projected revenue recognizable according to General Accepted Accounting Practices (GAAP), GAAP revenue for short, at the end of a given time period, typically a quarter or a year. With SOX, the GAAP revenue recognition rules have become very strict and complex. Within a corporation, the Chief Financial Officer (CFO) is thus the best qualified person to judge the conformity of the revenue declaration with these rules. So it is probably the holder of the CFO role that should also be held accountable for GAAP revenue forecast.

Confusion about this accountability can come from the fact, that sales management's and in some cases even sales peoples' compensation is linked to recognized revenue. This is done as a measure to prevent the sales organization from bringing in bad business by taking in orders for things that cannot be delivered or where the cash cannot be collected. The compensation aspect should however not be mixed with the forecast accountability question.

Undoubtedly though, sales activities are at the heart of the revenue generation process. One can thus expect that the sales function should be able to predict demand and thus can be held accountable for the order input forecast. There are though several transformation steps between an order input forecast and a GAAP revenue forecast.

The demand forecast is the input for the Sales and Operations Planning Process (S&OP) which essentially produces a supply chain constrained delivery forecast as output. So effectively a team of executives becomes accountable for this forecast. If it should be one person, instead of a team, then the holder of the COO position is probably the best candidate. From the supply chain constrained delivery forecast, billing can be predicted and the forecast for cash inflow, probably the most essential forecast for the health of the corporation can then be established in a rather straight forward manner.

The GAAP revenue forecast cannot be derived directly from either of these forecasts. Due to the complex recognition rules, it is not necessary tight to the billing forecast as one might expect. One of my customers told me even of cases, where the cash was already in hand, but revenue could not be recognized according to GAAP rules as some formal criteria were not yet met.

Especially if selling is primarily account management driven, there is yet another temptation to try to make the CSO accountable for the GAAP forecast. As the account manager is the primary interface to the customer, it is probably fair to expect that this function or at least the supervisor thereof , should be aware of the formalities to be observed to avoid problems with GAAP revenue recognition. If one believes that behavior can be influenced by financial incentives, tying compensation to GAAP revenue is probably strong enough and justifiable to insure that attention is paid to this formalities. As a minimum however at least sales management needs to be trained about their responsibilities to insure adherence to those formalities. But this does not mean delegation of accountability for the GAAP revenue. Revenue recognition rules are too complex to be judged by individual account managers or their supervisors. There is therefore too much risk of exposures for the corporation due to variation in interpretation. In addition and probably even more fundamental however is the supply chain's imminent role in the transformation of orders to revenue. This alone should make it advisable for the CSO not being accountable for more than the order input forecast.

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