By Paul B. Finch, MBA | 8/18/2022

Over my many years as a corporate CFO and, more recently, as an outsourced Financial Planning and Analysis (FP&A) professional, I have been puzzled over why so many hardworking, smart, FP&A teams engage in static linear thinking as it pertains to their financial planning processes. I have come to believe that it is because we are trained to be comfortable with simple budget models that have static, consistent, palatable rates of growth over time. We are comfortable budgeting for things that have already occurred and adjusting sales revenue, along with associated production costs, to achieve our targeted growth after the fact. Rarely are other factors considered.

Unfortunately, these less rigorous processes lack the agility to make accurate forecasts, anticipate threats, take advantage of competitive opportunities, adjust strategies and tactics in real-time and, subsequently, make good financial decisions. Accordingly, such static linear thinking ultimately inhibits a firm from achieving the long-term sustainable growth and, thereby, value creation what would otherwise have been possible had their FP&A teams utilized processes that were more rigorous and agile.

Development of a Strategic Planning Process

Whether your firm utilizes a three, five or ten year planning model (or something in between), in order for a planning model to achieve long-term sustainable growth, the underlying planning process needs to be strategic in nature. This means being able to analyze evolving macro and micro trends in real-time such as (i) technology breakthroughs that achieve more effective and efficient operations; (ii) shifts in consumer behavior that affect demand; (iii) changes in the supply chain that can affect output; (iv) threats from the introduction of new products and services by competitors; and (iv) regulatory changes that affect the legal environment.

This being the case, the following is how I advise my clients to develop a more agile financial planning process that is strategic in nature that will foster long-term sustainable growth as well as create real corporate value:

1: Expect and Anticipate Change

While it is a human tendency to assume the present situation will remain the same going into the future, in reality, this is a fallacy. Often referred to as the “Parmenides Fallacy”, named after the misguided Greek philosopher who argued that the world was static and that all change was an illusion, the truth is that the world around us is constantly changing, and we must learn to adjust to these changes to survive.

Likewise, it is wrong to assume that business conditions will be the same from one year to the next and it is not sufficient simply to increase past year metrics by an inflation factor and call this “change”. FP&A teams need to expect and anticipate real change in their competitive environment.

2: Strengthen Forecasts Utilizing Driver-Based Planning

I have observed that the most successful organizations, and their financial planning processes, use a driver-based approach to tie financial forecasts to underlying economic drivers. Such drivers should have a causal relationship with a specific metric as opposed to a simple associative relationship which may not be predictive during periods in which a business is encountering an economic downturn or a shock. As such, driver-based planning tends to have an inherent advantage over simpler historical trend-based approaches and is an essential tool as it pertains to forecasting (i) revenue; (ii) operating expense; (iii) capital expenditures and (iv) cost of capital.

3. Further Strengthen Planning by Adopting a Scenario Framework

When utilizing the driver-based approach referenced above, it is important to further utilize a scenario framework that assesses multiple different potential forecasts for the economic drivers referenced above. Rather than attempting to arrive at a single predictive value for a given metric, FP&A teams should adopt a probabilistic approach assigning a weight to probable forecasts in order to reduce modeling risk and allow for agility when making adjustments by reassigning weights when it is deemed appropriate.

4. Adjust Models in Real-Time – Be Agile

Financial planning, to be effective and efficient, needs to be an ongoing process where variances are monitored and adjusted on a regular basis. By combining a driver-based approach to forecasting, aligned with a scenario framework, FP&A professionals can develop dynamic strategies, monitor actual performance and react to and make adjustments in real-time.

5. Utilize Valuation Analysis to Make Financial Decisions

Effective and efficient financial planning should also incorporate a process for valuing a firm’s equity as a means of making financial decisions. This is because, as a basic overriding principle of all strategic finance, decisions that provide for a greater increase in a firm’s equity value [sustainably over time] are superior to decisions that create less equity value for a given firm. This can be accomplished by assessing the equity value of multiple financial planning options to arrive at the optimal plan.

While this may seem to be a rudimentary concept, I cannot begin to tell you how many times I have seen FP&A “professionals” make significant mistakes in valuing a firm’s equity. In valuing a firm’s equity for planning purposes, it is important to utilize income based approaches and not market based approaches because market approaches do not provide a value based on the underlying conditions of the firm being assessed, and, therefore, are unreliable methods for financial decision making.

Additional Thoughts

It should be noted that in order to have an effective and efficient financial planning process, such as what I have described above, it is necessary to access valid and reliable business intelligence. While AI and Big Data can provide “boat loads of information”, it is ultimately up to FP&A professionals to avoid information overload, and “analysis paralysis”, by intelligently distilling this information down to only the relevant datapoints for a specific purpose so as to best achieve the firm’s goals and objectives.

Paul B. Finch, MBA, is co-founder and Executive Director for Benchmark Solutions, Inc. and is an accomplished Strategic Financial Advisor. Paul specializes in the areas of Financial Planning and Analysis, Decision Support, Business Valuation as well as M&A Advisory where he applies corporate finance and management accounting processes/methods as a regular part of his practice. You can contact Paul at paul.finch@benchmarksolutions.us.com