Modern FP&A: Some Important Techniques, Methods and Concepts

The world of financial planning and analysis (FP&A) has observed changes of such magnitude that they cannot be described by our traditional statistical and analytical models. In this age of frequent Black Swan events, the traditional business approach to operating on an annual budget and forecast is no longer effective.

In order to deliver a competitive advantage to a company, modern FP&A function needs to be flexible and dynamic, be based on sophisticated analytics, examine lifetime values of the products and services and encourage business partnering. This significant change in the role of the FP&A function requires a big cultural shift and modern change management techniques.

Flexible and dynamic planning process

A flexible and dynamic planning process is easily adjustable for different risk and strategy scenarios. It is multidimensional, driver-based, events-driven and activity-based. It uses advanced analytics and is not limited to the accounting period. It encourages collaboration between business functions and allows both top-down and bottom-up approaches to be used in the process.

Following are popular techniques for the flexible and dynamic planning process:

• Risk-adjusted planning
• Scenario planning
• Rolling forecast
• Activity-based budgeting and planning

Risk-adjusted planning

The risks enterprises face can destroy or create value. Historically, risk management has been a separate process within the organization, not connected to the FP&A function. Increasingly more companies are beginning to incorporate risk information into the planning, in order to evaluate and manage external and internal risk.

A risk-adjusted plan is one that responds to changing circumstances, providing the financial capability to react to events in a planned and proactive manner.

The time of one static scenario planning has gone forever. The identification of risk scenarios enables the organization to develop risk response plans applicable to many possible events, not just one specific scenario.

Scenario planning

At the time of rapid change, scenario planning is used to evaluate the risks and viability of different strategic alternatives. It is also used for sensitivity analysis. The standard approach of “three scenarios” (best, average and worst) is replaced with multiple on-demand scenarios. To arrive at one summarized view, a probabilistic and expected values approach could be used.

It is such an important topic that it requires a separate article. If you would like to learn more about the evolution of scenario planning or how businesses can move from traditional forecasting to scenario-based planning, please check out one of my previous articles.

Rolling forecast

Rolling forecasts are a planning method that refers to a process of forecasting trends that may impact your business 4-8 quarters in the future. With rolling forecasts, the number of periods in the forecast remains constant and visibility of the business does not stop at year-end. The idea is to do a new forecast every three months and add another three months to the end of your forecasting cycle on a rolling basis.

A rolling forecast is a better management approach since it gives management a view into the future.

According to APQC, the use of rolling forecasting (RF) can save a median of 25 days on an organization’s annual budgeting cycle. A rolling forecast expands planning horizons and challenges the traditional static budget. More and more companies are introducing RF into their processes, many of them use the process parallel to the traditional budgeting process.

Activity-based (flexible) budgeting

Activity-based budgeting is a very effective technique for cost management and in the time of global expense cutting this method has become very popular. However, this concept challenges the traditional view of a budget fixed for the year.

In an activity-based budget, variable cost is adjusted for the activity level throughout a year and cost managers learn to adjust to the idea that their annual budget is not fixed or based on previous years’ spending. It varies with the level of activity and could be lower or higher depending on the activity level. Therefore, the budget is dynamic, not static.

The concept needs to be communicated to departmental managers, and it needs to be controlled and analyzed by finance business partners before it becomes part of the business culture in the traditional budget organization.

Advanced Analytics and Driver-Based models

Many companies have recognized that spreadsheet-based planning methods are inefficient and have moved to specialized planning and forecasting systems. Modern FP&A should be based on a model with formulae tied to fundamental business drivers. This is a driver-based model which invokes consistency and participative cooperation across functions in organizations.

Advanced predictive analytics in the FP&A model is a source of strong competitive advantage.

Basic principles of driver-based modeling:

• Concentrate on top 10-15 business drivers
• Analyze and manage the drivers
• Look at their interdependence
• Explain the variances through the drivers
• Update driver-based models on a regular basis

Harmonization of the planning processes

In addition, strategic, operating and financial plans should be harmonized through drivers and ideally reside in one system. They should allow cross-functional collaboration and use automated reports that can quickly generate scenarios and easy multi-dimensional capabilities. The system should also allow top-down and bottom-up approaches to be used during the planning and forecasting process.

Conclusion

The FP&A world is a complex and exciting one to be a part of, particularly in these unstable economic times when a predictive capability is highly prized. FP&A is gaining increasing recognition as companies realize its importance and the need for alternative ways of doing business. It is certainly a field to watch, and more importantly to get acquainted with.

Disclaimer: The article was originally published on FP&A Trends. FP&A Trends is a global educational resource for FP&A professionals that covers a wide variety of FP&A-related topics such as artificial intelligence, beyond budgeting, integrated FP&A, driver-based planning, FP&A business partnering, FP&A analytical transformation, zero-based budgeting and etc.

If you would like to learn more about rolling forecasts or FP&A business partnering, please feel free to check out our free educational e-books:

• FP&A Trends E-Books: Rolling Forecast
• FP&A Trends E-Books: FP&A Business Partnering