Creating a Forecast: The Berkheimer Approach

Background

In the fall of each year, our management team ceremoniously huddles in our wise chairman's office to review results year-to-date against our plan and, perhaps most importantly, to gaze into the crystal ball that has been handed down through generations of management at Berkheimer, to discover what will transpire in the coming year.

Not unlike many economists, this very elegant process has accurately predicted six of the last three housing booms and eight of the last five recessions! Given its remarkable track record, the process has served the company well during its many years in business, and has spared management the need to spend many hours sifting through and analyzing the multitude of economic, market, customer and financial data available. We're just being facetious of course, but often wish it were this easy!

In reality, for 2011, we are forecasting growth of approximating 8 percent — consisting of 3 percent inflation and 5 percent real demand growth. How did we get to that number? Well, in some circles, they might consider the approach we use somewhat unorthodox, in that we largely “begin with the end in mind” and essentially work backward from that point.

The approach consists of asking three basic questions: (1) What do we want the forecast to be? (2) Is what we want realistically achievable? and (3) How do we make it happen?

I. Beginning with the End in Mind

In setting out to determine our forecast for 2011, we started out by looking at what we wanted to accomplish in terms of an overall return-on-investment objective for the company. As an ESOP company, we traditionally try to develop our forecast based on an adherence to fairly conservative principles and fundamental financial measures. We rely heavily on benchmark data we receive through HARDI and other trade associations — especially information provided through our participation in the HARDI Benchmarking programs as well as information from the Institute for Trend Research (ITR) disseminated through HARDI on a monthly and quarterly basis. Based on the most recent benchmarking data, the HARDI Profit Report indicates an average pretax ROI of 5 percent overall and about 20 percent for the high-profit group of HVACR wholesalers.

After establishing an ROI objective, we took a close look at our cost structure and made some reasonable assumptions or predictions as to where we think costs would be increasing or decreasing.

For a typical wholesaler such as ourselves, the primary categories are people (wages, salaries, benefits, etc.) and facilities. People and related costs often range between 55 to 65 percent of gross margin dollars; facilities and related costs often range between 10 to 15 percent of gross margin. So we give the greatest degree of focus to these areas but we also give careful attention to other expense areas. Some changes relating to these areas are quite predictable; others require us to make a few reasonable assumptions (for example, if we suspect that healthcare inflation and/or utilization will go up in 2011, as a result of recently legislated changes to coverage, we apply a figure to our current healthcare costs to arrive at where it will likely be in the coming year).