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Best Practices in Driver-Based Modeling

  • By Nilly Essaides
  • Published: 12/17/2015
For more insights on financial planning and analysis (FP&A) check out AFP’s latest FP&A Guides. DOWNLOAD

airscreenFacing greater market volatility and a fast-changing business environment, as well as constant push from senior management to improve the planning process, more FP&A teams are incorporating driver-based modeling (DBM) into their forecasting methodology. That’s the subject of the latest AFP FP&A Guide,  What’s Driver Based Modeling and How Does It Work?, which will release on January 16.

“One reason we see an uptick [in the use of DBM] is that companies are dealing with a lot of uncertainty and volatility,” said David Axson, managing director for CFO and enterprise value at Accenture Strategy.  “Historically, companies used historic data to trend their financial budgets and forecasts. They used last year’s data to predict next year’s performance. That’s no longer sufficient. Companies need to look at activity that’s occurring now to see what’s driving financial performance in the future.”

Best practices

Dozens of interviews with practitioners and experts produced seven key best practices:

1. Understand the behind-the-scenes factors. Tony Levy, business unit executive, business analytics at IBM Software Group, urges FP&A professionals to get educated and understand the factors behind forecasting. That means more than just driver-based modeling, according to Levy. “It’s understanding the principles of quality forecasting, i.e., how to create a more reliable forecast. Modeling is just one aspect,” he said.

2. Collaborate with operations. Companies that successfully deploy driver-based modeling in their planning process work with the business to define key drivers. Successful companies enhance the FP&A group’s effectiveness by continuously improving its understanding of the core operations of the business to better define candidate driver relationships and the selection of actual business drivers and gain other groups’ buy-in. FP&A can be the lead in identifying drivers, but it must validate the relationship in the context of the operations and multiple functional areas.

3. Apply robust technology. To support more sophisticated modeling, continuous improvement and model refreshment, companies must upgrade their technology even if they still work through a web or excel interface. It’s equally critical to ensure all the data is in one place and can be accessed readily on an ongoing basis. The ability to master a clear set of data is critical. Ultimately, companies need to actively go through and have good clear definition and house the data with absolute integrity around it.

4. Focus on what’s important. Successful driver-based models are based on specific domain areas and/or financial statement line items that could benefit from leveraging the framework. These could be line items that are significant, difficult to predict and forecast, and have a higher degree of volatility and variability. It’s easy to get into unnecessary complexity. “That makes it harder to get to the production phase,” said Vic Datta, CEO of consulting firm Resilicore. “The key is to simplify more and focus on what’s truly impactful, which means including the impact on the market, on customers in your analysis. Then test against performance and accuracy—make that a mainstay.”

5. Enhance existing capabilities. Another best practice, experts say, is to identify areas where some form of driver-based modeling may be already occurring within the organization and then look to enhance, extend and systematize this modeling as part of an integrated planning, reporting, and analysis environment.

6. Always back test. Driver-based models are only as good as their inputs. To make sure the models work, leading companies continue to back test their results, to both validate and refine the models to adjust for changes in business and drivers.

7. Integrate driver-based modeling into the FP&A process. Finally, successful companies make sure they have a financial strategy that’s linked to the planning process. This leads to analysis that drives the right decision, which can be reconciled to key drivers. “It should be a closed-loop cycle and not driver-based modeling sitting to the side. Integrate it with other processes,” said Jeff Wuest, president and CEO of consulting firm SynFiny and an ex-P&G FP&A practitioner.

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