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How to transition to a continuous forecasting model from budget cycles?





Let’s focus on driver-based planning


Unprecedented marketplace disruptions require businesses to reinvent existing finance processes, organization structures, and strategic imperatives. Forecasting process needs to be agile, predictive, and continuous.


To develop an effective rolling-forecast process, an organization needs to identify the right drivers that have an impact on the organization’s financial performance. Also important is the need to avoid an unnecessary lengthening of the overall budget cycle. The use of right technology, such as artificial intelligence and machine learning, to automate the process, where possible, can free up capacity within the organization to unlock value.


As much as we sometimes would like to think otherwise, in practice, mostly a traditional budgeting approach is still widely used. i.e., we begin by top-down growth targets (which are typically established by the senior management) and then attempt to develop a detailed, bottom-up annual or semi-annual budget, which is then broken down into quarterly and monthly sections.


From this, to move to a continuous forecasting model would mean parting ways with the traditionally long and arduous focus on the annual/quarterly budget development and adopting an approach which focuses on a rolling, driver-based forecast that identifies and builds on the specific business drivers that really matter. It is not just about building on prior years historic results to forecast future financials.


As an FP&A leader, you need to understand the real business drivers and develop an ability to collect and analyze the focused internal and external impactful data elements. Only then you can provide correct foundational models that the business can rely to confidently build a future projection. Your planning process must be more holistic and all forecasts must be fully aligned with the prevailing economic environment relevant to the functional area and the business as a whole.


How to identify the most relevant drivers?


Traditionally, FP&A professionals have been focusing on the annual budget process to predict how the next year would turn out for business. General volatility in the past decade and extreme disruptive events (such as COVID-19) or trends, triggered a shift of preference towards creating rolling forecasts. Such forecasting processes could be ad hoc or continuous in which FP&A is regularly modifying forecasts based on any event which could drastically change a company’s business drivers. Whilst COVID-19 is an extreme example, other disruptive changes, such as new regulations or policy modifications, are also events that ought to begin a reevaluation.


Identification of relevant business drivers must be a tested and repeated process, though it would vary from company to company. Finance and FP&A teams must begin the forecasting process with the help of a specific data set which they believe will correlate with the company’s financial results and perform analysis to understand whether there is positive or negative correlation.


For most companies, the core business drivers which are relevant and which the FP&A needs to focus are typically between five to ten. For a driver to be relevant, it must fulfill the criteria that it should have a clear and demonstrable relationship with the likely revenue, volume, costs, and any other applicable variable the business wants to model. Whilst identifying such core drivers, FP&A teams should also leverage the external data sets. Determination of future financial results needs a much broader view than historical company results alone can provide.


The real trick is to keep focused on the drivers that have correlation to financials. This will significantly increase the speed of the planning process as FP&A walks away from detailed manual process which is drawn out and is proven to be inefficient.


Why it works better for the business?


A rolling forecast mechanism which is based on relevant business drivers provides increased transparency. By focusing on such drivers, FP&A teams can better understand what really causes the business change and forecast the internal and external outlooks. Automation can further help with increasing efficiency i.e., with automation, continuous forecasting can be performed with a smaller core team with less manual effort. More and more companies are witnessing significant increase their forecasting accuracy year-over-year with this approach.


The need to align the forecasting process with your data strategy


It is critical for finance and FP&A teams to align the forecasting process with the organization’s overall data strategy. In essence it means business partnering to better understand how the business measures performance. Once that understanding is developed, finance and FP&A teams can develop a suitable enterprise data model. The goal is to gain the ability for sourcing data from the appropriate systems and organizing it in a fashion that could satisfy all reporting requirements.


Companies that have a data strategy in place can evaluate their business more effectively and measure performance on a consistent basis. With a driver-based rolling forecast approach they are able to focus on sophisticated statistical models and operational level reporting, whilst much of their financial reporting needs are automated.


This enables them to advise on value-inducing opportunities such as consumer demand quantities and identification of cost reduction possibilities, among other.


FP&A transformation at the core of driver-based continuous planning


For the development of an integrated, cross-functionally aligned planning solution, FP&A must transform. If the management is eager to increase the efficiency and effectiveness of the finance organization, FP&A must be recognized as a strategic priority.


FP&A transformation will lead to a number of positive outcomes, including:


  • Cost savings across the FP&A organization

  • Earlier visibility and increased transparency to potential risks and opportunities through realistic planning to support company-wide decision-making

  • Enhanced speed and flexibility to help deal with an ever-changing environment

  • Alignment between strategic plan and rolling forecasts through corporate goal setting

  • Improved forecasting accuracy by focusing on key drivers and assumptions

  • Reduction in cycle time and level of effort


Some concluding thoughts


In itself, a standalone extreme disruptive event such as COVID-19 alone did not inspire a shift towards continuous planning. However, it certainly acted as an accelerant. Suddenly, finance professionals did not know how to forecast what was going to happen across the business. It brought the realization that year on year growth forecasts cannot be taken for granted and to shed-off some of that inertia, businesses need to develop planning capabilities for rapid strategic analysis and adjustment.


FP&A teams must stop spending half the year on budgeting and start implementing a more insightful and accurate rolling forecast. The forecasting process should be aligned with commercial and operations teams to deliver integrated business planning. Management must strategically invest in technology and data and analytics capabilities for incorporating external data elements into the planning process. Planning must be viewed broadly across the organization and teams should be reorganized to optimize performance.


As FP&A teams work to develop capabilities and implement continuous forecasting, they should focus on the following broad objectives:


  • Forecast or the annual budget development process should no longer be a formal event

  • Alignment with commercial and operations teams to deliver integrated business planning

  • Continuous forecasting must be based on changes in business drivers and internal or external signals

  • Market dynamics must be identified timely and effectively. These trigger business drivers, which must prompt scenario planning and forecast refreshes

  • Higher-level planning and rolling forecasts should provide the foundation to enable continuous forecasting

 

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Strategic Finance Consultant ✅ ACS SYNERGY ✅ At ACS, we help growth seeking businesses with Finance Transformation, Accounting & Finance Operations, FP&A, Strategy, Valuation, & M&A 📧 Message me 🌐 acssynergy.com

Unprecedented marketplace disruptions require businesses to reinvent existing finance processes, organization structures, and strategic imperatives. Forecasting process needs to be agile, predictive, and continuous. To develop an effective rolling-forecast process, an organization needs to identify the right drivers that have an impact on the organization’s financial performance. Also important is the need to avoid an unnecessary lengthening of the overall budget cycle. The use of right technology, such as artificial intelligence and machine learning, to automate the process, where possible, can free up capacity within the organization to unlock value.


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