CFOs tasked with budget presentations often find themselves explaining numbers and assumptions that are far out of date by the time they stand before key stakeholders.
Consider these tasks and the problems related to them: budgeting amid great uncertainty about the future (like today during COVID-19); inputting departmental budgets on multiple Excel worksheets; manually reconciling variances and correcting errors; and dealing with broken formulas, misinformation, and inaccuracies. The life of a finance team during budget season is arduous and often frustrating.
It is more frustrating when there is uncertainty about the levels of demand on the organization in the future months.
CFOs tasked with budget presentations often find themselves explaining numbers and assumptions that are far out of date by the time they stand before key stakeholders. Static budgeting simply cannot keep up with today’s lightning-fast economic environment, as so many are now experiencing.
Progressive CFOs using driver-based budgeting, on the other hand, can create a dynamic and agile finance-centered process that helps stakeholders gain insights and make informed decisions tied to strategic and operational goals. This enables CFOs to transition from tactical to strategic leaders. They can align forecasts and projections with external as well as internal drivers (e.g., the impact of unforeseen events; changes to the corporate tax rate or labor contracts). They can expand from “bean counters” to “bean growers.”
This is critical because driver-based budgets not only generate a pro forma income statement and balance sheet for each month into the future but also the cash flow statement derived from them. With this information, the treasury department can plan for investing surplus cash or financing deficit cash. Sadly, bankruptcies occur when organizations run out of money and have exhausted their financing options.
A Strategic Budget Tool for a Fast-Moving World
Driver-based budgets accomplish more than static budgets, and they do it faster with more validity. In addition to allocating resources based on forecasted demand load to adjust capacity (e.g., number and type of employees, equipment purchases), driver-based budgets enable CFOs to help drive business priorities, respond more quickly to changes in the marketplace and external environment, and create a dynamic, data-driven process, rather than one frozen in countless racked-and-stacked Excel workbooks. Driver-based budgets enable active and continuous budget planning that becomes rolling financial forecasts, rather than annual and fixed planning that culminates in hundreds of unread pages.
Agility is a buzzword for a reason. CFOs hoping to build confidence and credibility in their numbers can no longer rely on static budget tools to get the job done. In a world with increased regulatory volatility, complexity, uncertainty, supply chain mobility, labor market changes, and technological evolution, a CFO must be agile, or generate irrelevant reports and budgets that no one reads or believes in.
Here are there tips to help CFOs get started with driver-based budgeting.
Eliminate Data Silos
Traditionally, CFOs assemble budgets using data from multiple sources throughout the organization. Departments enter their budgets into cost center spreadsheets with little or no idea how their performance ties to larger initiatives. The finance teams are stuck with consolidating the spreadsheets and left guessing how everything fits together. This siloed approach to budgeting keeps stakeholders in the dark about the impacts of revenue and expense projections downstream.
Regardless of company size or industry, CFOs can achieve greater collaboration and eliminate budget silos by identifying a single source of data, generating driver-based rolling forecasts, and creating a centralized and accessible planning resource. Upstream data integration helps operational units view budgets in a larger enterprise-wide context and makes it easier to line up support from key stakeholders.
Ultimately, eliminating silos creates a dynamic budget process that drives rather than reacts to business performance. The budget process is resource-capacity sensitive to projected changes in the sales volume and mix of products and standard service lines. It takes into account which expenses are sunk, fixed, step fixed, or variable. It embraces microeconomic behavior compared to consolidating cost center spreadsheets.
Identify KPIs that Drive Finance and Tie to the Operational Plan
KPIs are measures of operating activities that encompass everything from customers to installations to deliveries to transactions. CFOs might track different KPIs (e.g., bookings versus revenues, sales by geographic location, on-time customer order delivery performance), but more KPIs isn’t always a good thing. All of the measured indicators cannot be a “K”—a key one!
In the case of one healthcare organization, disagreement about KPIs nearly derailed the budget process. Tasked with tracking patient-specific revenue, the budget committee initially identified quality of care metrics as a revenue KPI. The assumption that satisfied patients would return to the facility for care, thereby driving up revenue, ultimately proved less accurate than conducting a demographic analysis. Eventually, the budget committee concluded that indicators like patient age, location, income, race, health status, and utilization histories were more effective KPIs than stand-alone satisfaction metrics. This materially changed the budget and aligned it more closely to organizational goals.
Integrating KPIs into the budget process empowers CFOs to make course corrections, which is particularly relevant now, and to measure overall business performance. It enables CFOs to align the planned expenses with the strategy of the executive team while creating buy-in throughout the organization.
Differentiate Forecasts from Targets
CFOs using driver-based budgeting and rolling financial forecasts must differentiate between forecasts—where the organization is headed—and targets—where the organization hopes to go. Forecasts should be based on a run rate of previous performance with adjustments for increases or decreases of demand on the needed capacity, whereas targets tie to aspirational goals (market expansion, new product and service line launches, etc.).
By separating targets and forecasts, CFOs create a robust budget process that continually course-corrects and adapts to market factors and environmental impacts. They can understand the gap between projected spending and profit levels and the aspirational desires of the executive team. They can then try to identify actions that can narrow the gap.
Investors in a new production facility, for example, would need the finance team to present scenarios based on when the facility would be online, potential construction delays, and other unknown variables. A driver-based budget-oriented CFO would ask important questions like: Do we have a hiring plan in place? What happens if the product components increase from $40 apiece to $50 apiece? She would create best, worst, and likely scenarios against which results would be measured. Targets, on the other hand, relate to where the organization (whether board, leadership, or investors) hopes to go. In the case of a new facility, the revenue target might be 100% production-ready by the next quarter.
Plan and Execute
Today’s CFOs are expected to navigate complexity and uncertainty through standardization, automation, and the streamlining of processes, systems, and data. Driver-based budgeting and rolling financial forecasts help report cash flow projections for the treasury department, support growth initiatives, drive profit margin expansion, align with executives’ strategy, and manage business performance through better analytics and reporting.
This article was written by Gary Cokins, an internationally recognized expert, speaker, and author in enterprise and corporate performance management (EPM/CPM) systems.