A big part of where financial planning and analysis (FP&A) sits on the maturity curve is determined by what budgeting and forecasting techniques it uses in the planning process. In the past, budgeting and forecasting were quite static. The budget was created weeks prior to the start of the fiscal year; it was outdated even before the start of the year, yet everyone was expected to meet its targets, and FP&A measured actuals vs. budgets every month. It didn’t matter if the economy tanked, or a new competitor moved in; the budget set the stage for the allocation of resources and management compensation and was locked in before the year began.
For many companies, too, the forecast was created at the start of the first month for the 12 months to year end. Every month, FP&A compared the month-end forecast to actuals, noted the variance and re-forecasted to the end of the year. It created what some called the snowplow effect. All the missed expectations were loaded into the latter part of the year. Obviously this was not a very agile or market-sensitive way to operate, or a very realistic view of the future. It also gave no indication of what’s going to happen after the end of the year. In month 11, management had a view only through the last month. It was blind afterwards.
Survey shows dramatic change
The results of AFP’s 2016 FP&A Benchmarking Survey confirm anecdotal evidence that in the past three decades, things have changed. More organizations have adopted new ways of forecasting and budgeting that reflect the reality of a faster, more global and fiercely competitive business environment. Closing the bank even before the fiscal year begins has meant companies cannot adjust resource allocation in order to remain agile. Looking out to year end does not give management sufficient time to adjust course.
Certainly, there’s still a majority of companies that budget based on last year plus a percentage (63 percent according to the survey). But refreshingly, a full 39 percent are also using zero-based budgeting (ZBB), a technique that doesn’t not take last year’s numbers and assumes they make sense this year.
This may come as a surprise to some, but the adoption of ZBB has been a big trend in the past couple of years. It’s also the subject of the AFP FP&A Guide, ZBB 2.0: A New Take on an Old Method. Unlike the “last year plus” approach, ZBB advocates starting each budget cycle from scratch, so managers have to justify every expense for every activity. ZBB 2.0 approaches different departments on a rotating basis and hones in on areas of cost volatility or particular concern. The objective is to align the cost structure with the organization’s strategic objectives and achieve cost savings that can be reinvested in growth.
ZBB is not the only technique that’s gaining momentum among financial planners:
- 57 percent use driver-based modeling. Driver-based models take business drivers and identify the mathematical relationship between them and their key financial outcomes, then translate those into algorithms that help link the two to explain what happened and what’s likely to happen if the business makes certain operational decisions.
- 48 percent rely on activity-based budgeting, which similar to ZBB tracks expenses down to the lowest level. Instead of giving marketing or sales a budget, it assigns a cost to each activity.
- 48 percent are using rolling forecasting. Rolling forecasting keeps a continuous look forward on an 18-24 month basis and is typically updated every month or every quarter so that FP&A can supply management and business partners with a view of what’s coming down the road and how to adjust course if needed to reach financial goals.