Planning & Forecasting

Now that we have spent some time discussing several problems with traditional budgeting, let’s look at some alternate approaches. Here is a review of the first three problems from my prior blog:

• Time Consuming and Costly
• Quickly Irrelevant and Outdated
• Financial Process Largely Disconnected from Specific Drivers

The biggest problem to me is the overall value (or lack thereof) that a traditional budgeting process provides the organization. The concept is sound. The execution is where the opportunity lies.

One of the first steps is to determine the correct level at which to forecast. I’m referring to the number of accounts and entities (cost centers, profit centers, store fronts, functional areas, etc) you choose to budget. We often believe that more is more. In my experience, that is not true at all. Less is more. More detail means more time, not necessarily a better plan. There will always be puts and takes in your numbers as the year progresses and you compare actuals to budget. But if you build a very granular plan at the beginning, I have found that you end up with more misses. This is due to the budget review process where it is easy to look at the numbers through rose colored lenses. “The powers that be” make you bring every account or entity that is worse than prior year back to PY levels while keeping the goodness already baked in to other locations and accounts. You rarely get the offset so you end up with an unrealistic plan since we only take away one side of the equation.

Plan at the lowest level required for operational planning so you can get people, product, and capital in the right places at the right quantities. Your plan needs to be strategic in nature and should provide enough detail to allow for downstream capital planning. Don’t waste your time getting caught up in the weeds because the value add is simply to low. You must strike the right balance between detail and value to the company. As you spend time collecting numbers and assumptions for a given item, always ask yourself whether it provides actionable intelligence that will help you make meaningful decisions that drive the business forward.

As we learned in a prior blog, almost 50% of respondents stated that their business plan was outdated 1-3 months into the plan year. Wow!  Many of us spend several months on our plans only to have them become useless shortly after they are finalized. They become a variance column on our monthly reporting and then we just use it to see if we are on track for our bonus or not. If we agree that a business plan can still add value (which I do), then we need to find ways to shorten the amount of time it takes to complete.

One way that has multiple benefits is to make your budget driver-focused. Not only will this make the update process quicker, but it will help you connect your budget across all functions in your company. You need to ensure that your budget does not become a simple numbers game by aligning with operations, marketing, IT and others to build linkages throughout the organization, understand their needs for the upcoming year and create a shared vision that you are all marching towards. Choose the Key Performance Indicators (KPIs) that drive your industry and incorporate those into your planning process so you can quickly update your revenues and expenses. In my FP&A days, I focused on Rate per Day, Rate per Transaction, # of Transactions, # of Days, Transactions Per Employee, Average # of Vehicles, % of Revenue, etc. Armed with these assumptions, you can quickly update your budget when the need arises. Use these drivers to plan variable costs and then utilize a simple inflation factor to plan for your fixed costs. Here is a basic construct I have used successfully for many years:

(Rate * Driver) + Increment

The first part is clear. The increment is important because it provides the ability to plan for one-time items without having to artificially alter a rate to back in to the number. Without an increment or adjustment account, we lose the power of iteration as we can no longer simply update the driver because each rate needs to be reviewed as well to normalize it again for your starting point. Let’s say I have a particular expense that typically runs $100 (rate) per widget (driver). But I know that next month I have a one-time expense of $250 (increment). Using the above formula, I can easily increase my account by $250 to incorporate the one-time items. You can also use this to make last minute adjustments to your rate driven accounts without creating unrealistic rates.

While there are many changes you can make today that can help you avoid these pitfalls, we only had time to discuss a few here. We will look at a few more strategies in my next blog. As always, if you have some ideas to share or want to discuss further, please reach out.

Read more blog posts in Brian’s FP&A Done Right series:

FP&A Done Right: There is Life After December – The Fixed Forecast Dilemma

FP&A Done Right: Beware of Budgeting, Part I

FP&A Done Right: Beware of Budgeting, Part II