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SWTCH by Pigment
Three days of predictions, insights, and advice from leaders in finance, sales, HR, supply chain and more
Register now here
By Alan Dybvig, Managing Partner at Dybvig Consulting
Alan Dybvig
Alan Dybvig is the managing partner of Dybvig Consulting. His intellectual property was implemented to create the operational budget (OB). His business experience includes 32+ years with IBM as a director and senior manager, primarily in supply chain and sales/marketing assignments, and then four years with a Warburg Pincus-financed supply chain startup where the idea for the OB germinated. He has had five articles published in the Journal of Corporate Accounting and Finance, two articles in the Institute of Management Accountants’ Strategic Finance and one each in the Institute for Business Forecasting's blog and INFORMS’ magazine, "OR/MS Today".
Alan Dybvig's LinkedIn profile: https://www.linkedin.com/in/alan-dybvig-0a374ois/
This is the third article in a series of articles devoted to the wide variety of the benefits provided by the next generation budget, the operational budget (OB), and its associated operational income statement (OIS).
This article will describe an OB test case demonstrating that the OB really works. The first two articles focused on:
Part 1: Next Generation Budgeting, described how predictive and prescriptive analytics make OB possible and how easy it is to demonstrate OB’s value for a firm. NOTE: If the reader is unfamiliar with the first article, OB’s benefits described in this and subsequent articles will not be fully appreciated.
Part 2: Operational Budget’s benefits for the budgeting process
This article has four sections: i) background, ii) summary of OB’s results demonstrating it really works, iii) details of the OB’s model structure and data and iv) conclusion.
After having successfully implemented the intellectual property (IP) in the OB modeling software, the author of this article had a question: would it really work? Where can we get the data to build a test case model?
Fortunately, the author and his colleague had discovered that in addition to the three traditional data sources a fourth data source existed: activity-based costing data. The colleague had such data from a previous ABC engagement at McCoy Belt Company (disguised).
They decided to investigate the extent to which McCoy may have made errors in allocating sales and marketing expenditures last year and the impact of these mistakes on last year’s operational results:
McCoy hired a consulting firm to create an OB model of the last year’s results. To answer the two questions above, the OIS model had to be configured as both a profit and a revenue model with the following parameters:
The results included four scenarios:
Summary of Results
Scenario | Revenue ($) | Profit ($) | Sales/marketing ($) | Sales/Marketing ROI % |
Baseline | $136.3m | $12.7m | $28m | 45% |
Revenue max | $143.8m (+6%) |
$16.3m (+28%) |
$28.6m | 57% |
Profit max | $140.9m (+3%) |
$19.8m (+56%) |
$23.6m | 84% |
Table 1: McCoy Belt Buckle Company Results (FE +20%)
Scenario | Revenue ($) | Profit ($) | Sales/marketing ($) | Sales/Marketing ROI % |
Baseline | $136.3m | $12.7m | $28m | 45% |
Revenue max | $173.4m (+27%) |
$30.0m (+136%) |
$34m | 88% |
Profit max | $170.5m (+25%) |
$33.5m (+164%) |
$33.5m | 116% |
Table 2: McCoy Belt Buckle Company Results (FE +200%)
Table 1 and 2 illustrate the power of the operational budget (OB) to identify any firm’s unrealized profit and revenue opportunities that were left on the table last year. Such a test case also serves as the business case for the firm to deploy the OB.
The assumptions made for this test case are detailed below.
Test case operational budget model structure included:
One facility: US plant/distribution center
Two products: standard and custom
Nine customers:
Links between plant and all customers for all products
Eight response functions
Thirty three activity cost functions
NOTE: The OB data associated with this structure is too voluminous for this article. For more details, please click here.
The next three articles will describe how the operational budget can enhance three techniques that have been developed prior to the OB to improve on the traditional budget. They are i) the rolling forecast, ii) a management model that eliminates the traditional budget altogether and iii) zero-based budgeting.
Following those three articles, there will be an article describing benefits for two functions outside Finance (S&OP/manufacturing and sales/marketing) and a cross-functional application (scenario planning).
The concluding article will describe how OB’s analytics can be applied to extend M&A’s current advanced analytics.
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