In this article, I want to make the case for data-driven planning to describe the 7...
Different Planning Methods for FP&A
In this article we will look at the different methods an organization can use to set direction.
Planning involves many kinds of methods that help managers make decisions. It goes without saying that any planning system must be able to handle both financial and KPI information, it must be able to model the different business structures (products, departments, customer groupings) and possess good reporting and charting capabilities. It should also be able to report data from both a financial viewpoint as well as a strategy view through dashboards and strategy maps, as well as be multi-user that allows secure access to people with different roles.
On top of this, a planning system must also possess a range of specific capabilities whose purpose is to helps an organization prepare for the ‘unexpected’. These capabilities include:
- Driver-based Planning.
- Initiative planning.
- Scenario Planning.
- Contingency Planning.
Driver-based planning is used to predict future values based on trends and relationships between different measures such as costs, revenues and KPIs. By entering a number into certain accounts known as ‘drivers’, the model will then calculate related information.
Drivers are set by taking a target measure (e.g. revenue or some other ‘outcome’) and establishing what directly impacts its value. For those items, we then establish what impacts them – and so on. Measures at the end of the chain are known as ‘drivers’. Where possible, ‘Drivers’ need to be validated against past behaviour
For example, the drivers of Net Profit could include price per unit, unit cost, No. of visits and sales conversion rate. By entering data into these measures, the model is able to calculate Net profit.
These models also recognise constraints such as production volume and that at certain levels cost and revenue profiles may change e.g. the impact of discounts, late delivery penalties, or that more staff will be needed which will cause a step change in values. They also recognise that there is nearly always a time-lag between the driver and the result it supports. Driver-based models are good for modelling the relationships between activities and can be used to quickly generate future outcomes, but without the time, effort and politics involved in setting these values.
However, these models only work for a certain measure such as costs/revenues that can be directly related to drivers. Other measures such as overheads will be required to get the full picture. Also, they do not take into account unpredictable external influences such as the weather and they can only model what has happened in the past, which may not be a reliable indicator of the future in a volatile market or where product life cycles are relatively short.
Initiative planning recognises that it is the impact of specific actions that can help manage a change to the organic growth of an organization. Initiatives are in effect a project that details:
- An action to be performed
- The department(s) involved in its delivery
- The person responsible for overall delivery
- The reason(s) why they are being performed and the measure of success
- The timescale in which it is to be actioned along with defined start /end dates
- Milestones through which the status of implementation can be monitored.
- Resources that will be required.
Initiatives can be linked to drivers such as in the driver-planning model described above.
The difference in this planning model is that initiatives can be combined in different combinations and they can be moved back and forwards in time to see how they impact overall results. For example, if we delay initiative three by 2 months, what would be the impact on revenue and costs? Or, what if we dropped initiative two, could we bring forward initiatives four and five?
It is only by doing this kind of analysis, that the best use of resources for a given set of constraints can be determined.
Scenario planning can be used to assess different combinations of drivers and/or initiatives so that a choice can be made as to which achieves the best outcome in both the short and long-term, that is the most affordable and has the lowest risk. David Axson in his book on ‘Best Practices in Planning and Performance Management’ comments that: “Planning is not about developing a singular view of the future: one of the most valuable elements of any planning activity is the ability to factor in the impact of risk on assumptions, initiatives and targeted results. A scenario is a story that describes a possible future. It identifies significant events, the main actors, and their motivations, and it conveys how the world functions.”
Scenarios can include entering a range of driver values, trying out multiple combinations of initiatives and looking at the impact of a change to organization structures. The end result is to allow the side-by-side comparison of these scenarios, showing outcomes, any assumptions made as well as details of changes being proposed.
Contingency planning is similar to scenario planning, however, its purpose is to review the impact of a number of ‘What if?’ situations on current and forecast performance. For example, what would be the impact on profitability if raw materials were to rise by an unexpected 5%, or if the sales forecast was out by more than 10%?
Contingency models evaluate the outcome of these events and then allow managers to prepare a series of responses or initiatives that would mitigate or take advantage of such an event. Their aim is to help the organization prepare a ‘backup’ plan that can be implemented quickly.
Linking Plans to Budgets
Budgeting is concerned with resourcing a chosen scenario for a given business environment. Budgets should consist of three parts:
- The resources required keeping the business going for the predicted business environment assuming no changes to the way the business operates. Some of this can be derived from driver-based planning models.
- The resources required for chosen strategic initiatives to change/improve the operation of the business model. This can be set through initiative / scenario planning models.
- Other resources not covered by the previous two parts. This will typically be manually entered or fed from supporting systems.
Together, the three parts make up the complete budget for future periods. Although most organisations conduct this process on an annual basis, there is no reason why it can’t operate on a continuous basis as advocated by the Beyond Budgeting movement.