managing uncertainty: forecasting ... and guidance...06/09/2013 1 managing uncertainty: forecasting...
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MANAGING UNCERTAINTY: FORECASTING TECHNIQUES FOR FINANCE DIRECTORS
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Nottingham Business School
CIPFA: Central Government Finance Conference
Roger Latham – Visiting Fellow
Malcolm J Prowle - Professor
September 2013
The speakers Malcolm Prowle
• Professor at NBS • CIPFA member • Former senior finance manager • Former consultant with
KPMG/PWC • Background in finance and
operations research • Experienced business modeller
Roger Latham • Visiting Fellow at NBS • CIPFA member and former
President • Former FD and CEO of a large
county council • Qualified statistician and economist • Undertook forecasting analysis for
various organisations
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Co-authors of: • book on public services and austerity • research report on strategic financial leadership in the public sector • CIPFA publication on forecasting • many journal articles
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Themes
• Challenges facing public services
• Changing role of finance managers
• The role and importance of forecasting
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CHALLENGES FACING PUBLIC SERVICES
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Challenges facing public services
• Rising service demands – ageing populations
• Very low growth or decline in resources
• Austerity will be prolonged
• The importance of strategy
• Robust and sophisticated financial analysis will be needed
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Population ageing – the numbers % Elderly in (65+) in the population:
UK Sweden Japan China India
1995 15.5 17.3 14.1 6.1 4.6
2050 22.6 22.3 30.2 18.2 14.9
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Population ageing The very elderly in the UK population
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2013 2020 2030 2033 % % % % 65-70 31 27 27 26 70-80 43 45 40 40 80-90 21 21 25 24 90-100 5 6 8 9 100 & over 0 0 0 1 Elderly Total 100 100 100 100
% Very Elderly( 80+) in the UK population
Year % 1971 2.3 1991 3.5 2025 5.0 2033 7.2
The ageing of the elderly
Source: ONS
Population ageing Changing population structures
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Population ageing – the costs Relative health services expenditure by age group
Age Group Expenditure per head (£) StandardisedBirth 2655 5.0
under 5 794 1.5
5 to 15 185 0.3
16 to 44 328 0.6
45 to 64 459 0.9
65 to 74 949 1.8
75 to 84 1684 3.2
over 84 2639 5.0
Average 530 1.0
Source – Office for Health Economics 1990
Available data on social care (not much) suggests a similar profile
Population ageing – the consequences
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The economy is flat lining
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-6
-4
-2
0
2
4
6
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1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33
GDP annual growth %
Years 1980-2012
Series1
Source: IMF statistics
Austerity What they say now
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Austerity will last until 2020 (2013)
The public sector is only halfway through the reductions needed to achieve the deficit target (2012).
Austerity will continue until 2020 (2012)
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Voyage of Discovery
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McKinsey’s ‘Three Horizons’ of response to the recession (adapted to the public sector)
H1. Bridging
H2. Don’t Waste
a Good Crisis
H3. Paradigm
shift
• Coping strategies
• Trim fat, be flexible – sees us through
• Have contingency plans in case of worse
• Quick fix, rough justice, equality of pain
• ‘Reset’ costs at lower levels, take on sacred cows
• Be aggressive early
• Support top priorities and slash lowest
• “Wither on the vine” or “make it self-sufficient” alternatives
• “Use it or lose it” challenges
• Shift resources to strategic priorities - remove legacy services
• Schumpeterian technology shift
• Fundamental reorganisation (ending “command and control”)
• Shifting the public/private boundary
• Changing expectations and behaviour
From: Paul Jansen, McKinsey and Co, Forum on the Future of Higher Education, June 2009
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The Three Horizons
Horizon 1 is a current paradigm that works well until changes in the environment plus its own diminishing returns put it on a a curve of decline. Meanwhile Horizon 2 , aware of this in diverse ways is innovating more effective approaches which eventually overtake.
In the background, a completely new paradigm is emerging as Horizon 3. It appears for a long time to be marginal and ineffective but since it matches better the new environment it eventually takes over. The Horizon 2 innovations have served as enabling the transformation.
PREVALENCE
TIME
H3
H1
H2
“After the Downturn”- CIPFA/SOLACE Strategic Options
1. Big State/small State - Redefining the relationship
between the State and the individual
2. A significant de-layering of the public sector with
many more decisions taken locally with the minimal
oversight
3. A major initiative to maximise economies by much
more effective collaboration between public bodies
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Mapping to Strategic Options Big State/Small State Delayering &
Devolving Collaboration
H1 •Capital cuts •No reinvestment •Stop grant aid •Cut least favoured/defended services
•Tax/charging increase •Cash limit freeze •Pay freeze •Benefits freeze
•Cut partnership overheads •Axe Quangos •Common Purchasing
H2 •“Big Society” •Co-production •Service prioritisation •Pensions
•“Use it or lose it” •IT led investment •Seed corn funding
•Public/private partnerships •Shared Services
H3 •Reducing income/wealth inequalities •Self sufficiency for lower taxes •Sustainable communities
•Organisation change and takeovers •New technologies •Systems thinking
•Reorganisation •Community outcomes plans • Theory “U” Partnerships
• This is all very complex and there are huge financial implications in all cases
• Financial analysis and evaluation must inevitably become more complex and sophisticated
• This is what has happened in many parts of global business – why not in the public sector too
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CHANGING ROLES OF FINANCE MANAGERS
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Changing roles for finance managers
Source: The Hackett Group
Analytical Services
Transactional Services
Analytical Services
Transactional Services
Process and technology enablers
Managing the finances Managing the business
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Strategic financial leadership in public services
• Focus on sustainable and effective strategies
• Focus on robust strategic financial analysis
• Requires considerable up-skilling by many
• Strategic finance managers must also provide leadership
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Areas of increasing importance
• Cost and cost driver analysis
• Performance analysis and reporting
• Budget setting
• Forecasting
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Source: The Hackett Group
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Outside the Comfort Zone
Accounting –Budgeting
and Financial Planning
Statistics – Forecasting, Hypothesis testing, and prediction
H1 H2 H3
“Traditional Competencies” New Requirements
“Too Academic”
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I don’t need to know this because...........
You can’t ignore it because......
• It’s not practical...
• It’s too technical...
• It will take too long – I haven’t got time....
• I can’t use the results – too uncertain
• It’s a core strategic requirement
• You may not need to do it yourself, but you need to know what can/should be done.
• “He who does not learn from history will be condemned to repeat it”
• Managing uncertainty is the name of the game
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THE ROLE AND IMPORTANCE OF FORECASTING
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Key aspects
• Role and purpose of forecasting
• Structure
• Approaches
• Risk and uncertainty
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Role and purpose of forecasting
• Definition
“A planning tool that helps management in its attempts to cope with the uncertainty of the future, relying mainly on data from the past and present and analysis of trends.”
• Some Applications
– Policy analysis
– Demand forecasting
– Financial resource forecasting
– Strategy development
– Service reconfiguration
– Managing budgets
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Structure of forecasting
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FORECASTING PROJECT
e.g. future service demand,
future costs
Forecasting Process Forecasting guidelines of
good practice
Forecasting Stages Forecasting
Methods/Techniques
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Forecasting process and stages
Process
• Roles and Involvement
• Approach
• Responsibilities
• Consultation
• Reporting
Stages
• Determine the purpose
• Establish the time line
• Identify items to be forecast
• Select relevant forecasting methods
• Gather data
• Make forecasts
• Validate forecasts
• Decision making regarding results
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Forecasting Approaches
Qualitative
• Surveys
• Structured discussion
• World Cafe
• Dephi Methods
• Theory U
Quantitative
• ARIMA models
• Multivariate analysis
• Monte Carlo simulations
• Linear Programming
• Non-linear Programming
• Chaos Theory simulations
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Perspective on Approaches
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Method Chosen %
Qualitative Quantitive
Explanatory Model %
None Pre-determined Emergent
Source: Study of published research on public sector budgeting over 30 years Sample size =85!!!
Risk and uncertainty Risk • Is...a state of uncertainty where
some of the possibilities involve a loss, catastrophe, or other undesirable outcome
• Measured by....a set of possibilities each with quantified probabilities and quantified losses
• Relative Frequency hypothesis – R A Fisher
• Conventionally measured • Insurable, risk pooling, mitigated • “Known knowns” and “known
unknowns” • What the Banks thought they had
controlled!
Uncertainty • Is....the lack of complete
certainty, that is, the existence of more than one possibility. The "true" outcome/state/result/value is not known
• Measured by ... set of probabilities assigned to a set of possibilities
• Adaptive iterations – Bayes theorem
• Cannot be conventionally measured
• “Endured” rather than mitigated • “Unknown knowns”, and
“unknown unknowns” • What did for the Banks!
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