Nilly Essaides, Director & Practice Lead, Financial Planning & Analysis, AFP
Imagine the unimaginable. An event like a legal scandal or a massive product recall hits your company. Financial planning and analysis (FP&A) shifts into crisis mode. Everyone wants answers—fast. FP&A will certainly have to be very flexible. The challenge is how to balance that reactive wave of requests with some of FP&A’s own proactive scenario planning so as to be more supportive of management decisions.
Before the crisis hits
- Prepare a playbook. “While finance can never know exactly what’s ahead, they can help the organization prepare for a potentially large shock by going through some scenario analyses,” said Rob Hull, chairman and founder of Adaptive Insights. “You want to enter the battle having gone through some war games.”
- Coordinate with ERM. It’s important that companies embed the principles of good risk management into their planning, forecasting, reporting and analysis, and decision-making processes. “Risk is embedded along the journey,” according to Philip Peck, vice president finance transformation at Peloton.
- Focus on cash flow. When coming up with advanced plans, companies should make sure that they focus on the key concerns (which may be more than net earnings). According to Steve Player, co-author of “Future Ready: How to Master Business Forecasting” and program director for the Beyond Budgeting Round Table North America, particularly in a severe downturn, cash flow is typically the first thought. So plan to include steps on how to raise or conserve cash.
Plan B: After the crisis strikes
- Develop a rapid, baseline scenario. For FP&A to be able to come up with a valid estimate of the financial impact, management needs to quickly develop a full response plan including financial, communication and operational responses. A well thought-out plan can give FP&A a baseline to work from. Without it, FP&A will be under extraordinary pressure to come up with a reasonable forecast and scramble to respond to management requests for more information as events unfold daily or even hourly.
- Reboot the financial plan. Toss out the budget. “Look at all the initiatives and decide which ones are mission critical or close enough to completion that benefits can be derived with minimal further human or financial investment,” said Rob Torok, a partner at consulting firm BetterVu. It will take a process of reprioritization to decide where to now deploy scarce resources.
- Look outside for forecasting assumptions. “Clearly, there will be no internal or historical data to use for assumptions,” Torok said. “Look at external data to assess the potential financial impact. FP&A can do the research and look at what other companies have had to spend, and over how long, because of specific types of risk events. Then FP&A can have more productive conversations with senior leaders to come up with the probable scenarios.
- Use probabilistic analysis. Very often, in cases of outlying risk events, risk scenarios are triggered by high-level assumptions and judgments rather than carefully defined risk drivers. Most companies then use sensitivity analysis, scenario planning and a method of discounting net present value (NPV) to come up with their potential outcomes. Risk-adjusted probabilistic approaches, like VAR, earnings at risk and cash at risk are still very new concepts for FP&A professionals but have been in use by financial risk professionals for some time and can be “borrowed” and utilized.
- Monitor 24/7. According to one finance executive at a company that suffered a big shock, when things get tough, it’s important to update and review the forecasts on a more frequent, fit-for-purpose basis. If weekly, biweekly, monthly or quarterly was the previous frequency, when extraordinary events hit, it’s incumbent upon finance to revisit its outlook on a frequent basis to ensure its continued relevance and to best position management to make informed decisions.
Many organizations have stumbled badly in the face of risk events, often blaming the problem and arguing that it was a ‘black-swan’ event and not one that they could have foreseen. The FP&A team can avoid this mentality by working with the risk function to develop a handful of response plans, according to Player. While these plans do not need to be excessively detailed, nor can they reflect all possible scenarios, they do form a solid starting point. In the words of Benjamin Franklin, “If you fail to plan, you are planning to fail!”
The reality, Adaptive Insights’ Hull acknowledged, is that many finance organizations are too busy with day-to-day data collection and management to be able to run what-if risk scenarios that may not have any immediate payback. The impetus must come from the top. “It’s critical that the board believes in forward thinking risk assessment,” he said.
Player agreed: “FP&A is busy doing variance analysis and creating budgets instead of doing more important work like planning for the future.” Changing the planning mentality frees up people’s time to focus on what’s really important. FP&A should be engaged in doing scenario planning before catastrophic events take place. “Once you do that, it’s a lot easier to refresh them periodically and look outside and at the horizon to foresee what else may happen,” said Player.