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When Budget Season Ends, What-If Season Begins

CFOs that have spent the past 6 months building a financial plan will need to shift focus to what-if planning come the end of January.

Here CEO Today hears from Ed Gromann, CPO at Centage Corporation, who provides a two-step guide that will give CFOs the ability to easily run scenarios and better predict the future of their organizations.

As any CFO knows, I’m actually not kidding. By the time the first month comes to a close and actuals come in, the plan you so carefully built will begin to be out of date. My company recently interviewed dozens of CFOs on the budgeting process, and every one of them told us they can’t expect their budget to reflect the reality of the year, no matter how hard they tried. One flatout laughed when I asked if his company’s budget would stay accurate for at least one quarter, explaining CFOs, by definition, are required to predict the future.

All plans are based on assumptions. Some assumptions are easy to make: you signed a five-year lease for this office space, so that is a fixed cost that won’t change. Others are beyond your control to predict. Last year New England experienced a particularly harsh winter, with temperatures plunging well below zero for a few weeks and wreaking havoc on all assumptions regarding heating oil costs across the region. And that’s just the start — interest rates, exchange rates and a host of global economic factors beyond your control have the potential to upend your plan. While you can’t control those factors, you can anticipate the impact of them and warn the CEO and Board as quickly as possible if any trends threaten the company’s goals set for the coming year. In other words, the moment budget season ends, what-if season begins.

Step 1: Identify Key Drivers

It’s a good idea for CFOs to begin what-if planning at the close of each month. This will allow you to assess if you’re on track to meet your high-level revenue, customer acquisition and operational goals, and make adjustments as necessary. Given that your organization is made up of a lot of moving parts, it’s not realistic to test every internal and external factor, so you’ll need to prioritize.

Start by identifying the key drivers of your plan — e.g. increasing sales capacity by 20%, borrowing money to open new retail outlets — and the factors that have a direct impact on those drivers. Hiring costs and interest rates can have huge impacts on these key drivers, so plan on developing a range of possible scenarios in order to assess potential outcomes ahead of time. If unemployment continues its decline, the company may face steeper hiring costs and salaries for new employees. If the Fed continues to raise interest rates, the company may need to curb its expansion plans a bit. The sooner you can spot these trends, the faster you can alert the C-suite and board that modifications to the strategy may be required.

Step 2: Stress Test

As we spoke to CFOs over the past few months, we heard of another kind of what-if analysis they’re doing these days: Sensitivity analysis is the quickest and easiest of the stress tests, in that it tests just one variable. Essentially, sensitivity analysis allows you to answer such questions: how sensitive are my plans to specific variables, such as demand that’s weaker than anticipated or escalating insurance rates. Sensitivity analysis is critical, because finance teams want to know the impact of these variables on their cash flow, balance sheet and P&L.

Fortunately, sensitivity analysis doesn’t require you to make changes to the underlying plan at all. All of the basic structures remain the same, you simply change the value of a specific variable. Compare actuals to plan, and perform sensitivity analysis on key variables as often as possible, preferably on a weekly basis.

While this may seem like a lot of work, think of it as giving your organization 52 chances a year to make corrections. And not for nothing, with 52 chances at a do-over, you’ll get a whole lot better at predicting the future.

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