Using Heuristics in FP&A

By Karl Kern, Founder/President, Kern Analytics LLC

Heuristics are rules of thumb.  Psychologist Gerd Gigerenzer believes heuristics are a necessary part of an individual’s decision-making process.  Heuristics can be used in FP&A as a way to make decisions about how organizations earn revenues and incur expenses.

Here is a heuristic that I use to make decisions about how organizations earn revenues:

Why would someone buy my products or services?

Revenues are more than products delivered or services provided; revenues are about the qualities of the products delivered or services provided.  Accessibility, courtesy, and durability are a few examples of the qualities within products or services.  As individuals, we purchase food from specific supermarkets and internet services from specific service providers.  Our reasons are based in large part on the qualities of the supermarkets and service providers we choose.  Individuals who are FP&A practitioners should consider this fact when conducting their work.  Revenues represent a validation of what people see in the product/service offerings of companies.  What people see is the accessibility, courtesy, and durability of products or services.

Here is a heuristic that I use to make decisions about how organizations incur expenses:

How are products delivered/services provided?

Organizations that sell products incur an expense called Cost of Goods Sold.  This expense represents the cost of the product sold.  Organizations that sell products or services incur selling expenses.  These expenses represent the cost of selling products or services.  Organizations that sell products or services incur administrative expenses.  These expenses represent the cost of supporting organizations. Thinking and learning about how these expenses are incurred provide insight into an organization’s effort to deliver products or provide services.

Applying the expense heuristic can focus on what people within organizations can control, i.e. their activities.  Perhaps people responsible for the cost of goods sold need to choose other vendors for materials or merchandise, improve the use of labour and overhead, or re-negotiate costs with existing vendors.  Perhaps people responsible for selling expenses need to change communication methods like using social media instead of radio/TV ads.  Perhaps people responsible for administrative expenses need to change how they train employees, prepare financial statements or purchase office supplies.  Changes in activities can lead organizations closer to establishing a clear relationship between why customers buy their products/services and how activities fulfil these reasons.

FP&A can be a very detailed process.  These details may hinder not only the quality but also the timeliness of information provided.  Perhaps using heuristics in FP&A can lead practitioners down a road to improving their work.

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