Nearly 80 percent of companies say they’re either practicing or planning to implement a driver-based modeling approach as part of their forecasting and planning process, according to new research by the Hackett Group.
According to an upcoming AFP FP&A Guide, What’s Driver-Based Modeling and How Does it Work?, in a driver-based approach, financial planning and analysis (FP&A) identifies the key operational drivers that influence financial results and builds mathematical models to express—and predict—the relationship, and hence the outcome.
Figuring out the good drivers
One of the key steps to making a driver-based modeling approach work is figuring out the right drivers. This is not always immediately transparent. Here are some tips on how you can identify the key drivers in your organization:
- Focus on materiality and volatility. According to the Sholape Kolawole, EPM transformation associate principal at The Hackett Group, companies should be guided by the line item’s materiality and volatility. “You have to look at your balance sheet and P&L to identify items that are most material and volatile and focus on creating drivers for those,” he said.
- Break things down. Next, Kolawole said, “companies need to decompose those line items and understand what causes that number to move up or down; figure out at what rate you can flex that number on. Sometimes the rate is fixed and only the volume is variable. Sometimes both change.”
- Follow the KPIs. While it’s important to consider materiality and volatility, David Axson, managing director for CFO and enterprise value at Accenture Strategy, advised companies to begin by identifying key performance indicators (KPIs). It all depends on the business growth strategy, according to Axson. A company that plans to grow through larger market share will have different KPIs than one that’s intending to outperform competitors.
- Boil it down. It is so easy to get down into the weeds and have 500 drivers. The trick is to identify the key drivers and which are actually drivers versus drivers that merely align with other drivers. One way to do that is to back test and find the drivers that most affect financial results.
- Look around. Historically, activity based costing (ABC) has been the best way to identify drivers, noted Vic Datta, CEO of consulting firm Resilicore. Today, “a lot of companies have to go back and see leading practices and what other firms are using or rely on consultants who work with multiple industries and can give you the headlights into what drivers are working,” he explained. Companies have to ensure financial analysts work closely with the business and have an ongoing dialogue to identify the right drivers.
The AFP FP&A Guide, What’s Driver-Based Modeling and how How does Does it Work?, will be published on January 22, 2016.