In the AFP curriculum for the FP&A certification is a chapter on the macroeconomic environment that can impact the business. The factors may be political, economic, social, technological, legal (regulatory), environmental—PESTLE as a mnemonic acronym. In recent years, the unforeseen disruptions in each of these categories seem to be increasing, which creates challenges for FP&A professionals.
Given the myriad of ways that volatility can hit a business, how should FP&A anticipate the potential impact it can have on the planning function—budgeting, forecasting, benchmarking, partnering, and risk management? How can repeatable reporting help finance share estimated vs. actual performance and provide insights to capitalize on during the next year, quarter, or sooner?
A new FP&A guide, underwritten by Workiva, examines the key elements of that process, and highlights how FP&A can manage the volatility that can have a major impact. In general, the approach is to assume that volatility exists, and therefore teams should prepare for it, and react quickly when it occurs.
Volatility is the potential for factors to change rapidly and unpredictably—especially for the worse. In the language of statistics, it is the measure of the spread of potential outcomes around a given item. The more volatile, the wider the spread of potential outcomes. This spread is the bane of the forecaster’s existence; planning wants a narrow set of outcomes so that it can align the organization and its resources—staffing, parts, timing, etc. Volatility creates the problem of wasted resources and expenses.
Volatility can come in many different forms, depending on the business age and operations, the industry, competition and regulatory environment. For example, weather is a major source of volatility for energy retailers. How much volume is consumed and therefore billed is very much is contingent on the weather, therefore, a lot of the forecasting energy retailers do has to take into account how weather is projected to deviate from historical norms.
“Most of the volatility on the wholesale side is driven by weather,” said the finance manager for an energy retailer at an FP&A Roundtable at AFP 2017. “Obviously, the cone of uncertainty on weather widens as the time horizon expands and predicting Mother Nature is always tricky. So we’ll make our best guesses using inputs available to us and then our supply desk, who procures the commodity for us on the wholesale markets, will hedge and trade accordingly.”
In healthcare, the government is the biggest source of volatility, explained Peter Geiler, FP&A, fiscal director for a nonprofit. The Patient Protection and Affordable Care Act changed his prior employer’s mix of customers, which then changed the behavior impacting the business. The new customers called more frequently and with different types of questions, leading to changes in the staffing mix and training for different responses.
Starting your plan
Let’s start with the supposition that volatility is unpredictable, and that “the best laid plans of mice and men often go astray.” How can we develop a resilient planning process that copes with volatility?
The first step is coming to the realization that volatility is the “new normal,” at least for the foreseeable future. It is therefore crucial for FP&A practitioners to develop processes that help them anticipate what could happen next.
When developing your plan, you have to understand that it’s a whole process that needs to incorporate potential pitfalls. “You want to have an active planning process that thinks about things that can go wrong,” said Bryan Lapidus, FP&A, CFO Advisory for Allegiance Advisory Group and a contributing consultant for AFP. Lapidus warns against “falling in love” with your models. He provided three key tips to keep in mind when it comes to modeling:
- All models are wrong, but some can be useful. Accept that all models represent expectations of outcomes that may or may not come true. Models can be useful by aligning expectations, presenting the best thinking converted into actionable, analytical form for decision-making.
- Make sure your models are up to date. Models are built at a time for a specific purpose, and then develop a life of their own; FP&A needs to make sure that the models are maintained and relevant to current situations, which requires validation of output and occasional updating. An outdated model, like outdated data, is death in planning.
- Run multiple models. A single model will reflect a single point of view; compiling views from multiple models can help you gain a clearer picture of the future and remind you that different assumptions can lead to different outcomes. Don’t base your entire plan around one source.
For more insights on how FP&A can plan for volatility, download the new FP&A Guide here.