4.1. Relevance
4.1.1 Information received
- If we receive information which doesn’t help us make decisions to increase our opportunities and to reduce our risks, we should ignore it.
- Any information appearing on our screens and in our in-trays should be judged against this rule!
4.1.2 Historical information and forecasts
- Decisions cannot change the past, only the future. Thus information used to assist in decision making should look to the future. The past is only useful to predict the future. So if the plane was an hour late due to bad weather last time we travelled we can't make a decision based solely on that information. We may be travelling from a different airport, on a different airline at a different time of day. However, forecast information can help decision making. Since we are booking a month in advance, no detailed weather forecast will be sufficiently accurate. We can consider the month of travel and draw general conclusions (November gives a risk of fog) plus we can look at previous punctuality figures for the flight and forecast a likely delay. So historical information is useful but only to increase the likelihood of an accurate forecast. Yet how much time is spent, by managers and their accountants, looking at historical data when they can’t change it?
- This is not really surprising, since risks can only affect the future. It’s a bit too late to worry about risks in the past hindering our objectives (it rained so I got wet)!
- Yet how much time is spent looking at information that looks forward and attempts to predict the future, and therefore reduce our risks? A lot less than is spent on historical accounts!
- If one of our objectives is to ensure the continued existence of our organisation, by reducing its risks, we need to make decisions which affect its future.
- To make decisions which minimise risks, we need information that predicts the future. This information not only consists of forecasts of future profitability but competitors’ press releases and web sites, news in trade journals and papers, attendance at exhibitions. Any information which gives us an indication of those forces which will affect our future needs to be identified and factored into our accounting forecasts.
- Forecasts are not budgets or expected ‘actuals’ against budgets, these figures are usually targets and therefore based on hope, as opposed to reality.
- Forecasts should be a realistic attempt to predict the future results, within a stated accuracy. Accountants’ efforts should be directed at getting forecasts as accurate as possible and explaining differences from the actual results.
- Forecasts will never be accurate but the attempt to get good forecasts will provide information about the factors which influence the organisation’s performance.
4.1.3 Risks
- We have clearly established that the management of opportunities and risks is linked to the management of information.
- The identification of risks will also help us focus on the future, since past risks are not relevant. In this context, the use of risk modelling software, such as @RISK is useful.
4.1.4 Information requested from others
- We need to tell our information providers: our objectives, the risks likely to hinder them and the related decisions.
- Information providers can then tailor the information they provide to our requirements. This saves their time and ours.
4.2. Accuracy
4.2.1 Realistic accuracy
- We must take accuracy into account when providing and requesting information.
- We shouldn’t expect any information provided to us, or by us, to be greater than we can reasonably measure or estimate. Thus, if we are asked for a forecast of sales in three years’ time, our answer should be in the form £100 ± 30m. The degree of accuracy we can provide will depend on the past data we have and our confidence in the assumptions we have to make.
- Yet an accountant may be happy to quote a profit figure like £124,675. But for various reasons, such as difficulty in valuing stock and debtors, the realistic answer is more likely to be £125,000 ± 3,000 i.e. between £122,000 and £128,000.
- Why is providing information to an unrealistic accuracy harmful? Because it implies that it can be determined to that accuracy and thus implies it must be correct (remember the Google figure of £66.59 for fuel?). Which of the profit figures quoted above would we trust? The first one probably, because it gives an impression of accuracy, while the second one gives the impression of uncertainty, since anyone quoting profit in a £6000 range isn’t confident. However, the reverse is true; the second figure is the more trustworthy, since it gives an accurate impression of the uncertainty of the number. Try selling that explanation to a Managing Director!
4.2.2 Start with the most accurate figures
- Some decisions may involve information of varying accuracies. Supposing we want to set up a restaurant and we need to work out whether, in ten years, we will have any cash in the bank. The conventional way is to try and estimate the sales, subtract the costs and see if there is any left over. The problem with this method is that the range of possible sales figures is very wide, after subtracting the costs we may be left with a range of answers from being bankrupt to rolling in money.
- However, start from the figures we know most accurately – the cost of renting and fitting out the premises. We can reasonably estimate the profit to be made from the average meal and can then work out how many diners are required to cover our labour and premises costs. If the answer exceeds the capacity of the restaurant, or requires us to open 20 hours a day, we know we need to rethink.
- By using this method, we have to make fewer guesses and those we do have to make are based on reasonable assumptions.
Now onto page 2
4. How do we put these principles into practice? (Page 1)