It is vital to generate realistic forecasts rather than forecasts that the board or senior management wants to hear. The board might want a 20 percent growth in net profit, yet management might see that only 10 percent is achievable with existing products, customers and capacity constraints. If the forecasting team reports what the board wants to hear, they are simply hiding the truth. Figure 1 shows what happens if the team reports what the board wants.
Figure 1: Hiding the performance gap.
In this example, only in the final quarter does the real situation become clear: a year-end performance below expectations. The annual plan, which was prepared in March for the new year that starts in July, is forced to match the stretch target and subsequent forecasts in June, September and December to keep up this charade. In reality, the truth was always a shortfall, as the dark line in Figure 1 demonstrates.
In the better practice scenario the board, when setting a stretch target, accepts that the organization might not be able to achieve it with existing resources. The bonuses would not be pegged against the lowered threshold. The early communication of the performance gap enables the board to think strategically about how we are to close the gap.