.png){kind=logo}
How often do you stray from budget due to the unexpected and external to the organisation?
Events that happen and are often not considered at the time plans are made. Think COVID, the Ukraine war, large spikes in interest rates. And yet how much consideration do we give the external during our budget cycle? Your organisation doesn't operate in a vacuum, and therefore our role in FP&A should be to drive more discussion about whats happening around us, rather than whats happening solely within.
Am I suggesting that you should be able to predict and budget for these these events? Absolutely not..
However, in the absence of a crystal ball, you can still glean value in the budget process by identifying how events could impact you, and assess a range of potential outcomes and scenarios at the time of your budget. Planning is uncertain, and more so than ever. Having an awareness however serves you well later, when the unexpected does happen, you already have a starting point with which to start to determine the affect this will have and therefore the actions that you will take.
Some are clearly more identifiable than others, and some do have an element of predictability and thus can be factored into your plans today.
Let's take the example of interest rates
As well as hurting the pockets of consumers through increases to borrowing costs, the most significant being mortgages. Interest rates also impact companies finances and therefore FP&A. We should by now have a clear understanding of how the current high interest rate environment we are operating in is affecting the business across:
- Impact on revenues from consumer spending for B2C businesses, or those that sell into a B2C customer base
- Increased costs to investment and expansion decisions, often leading to companies delaying investment decisions
- Increased costs of borrowing on new and existing debt
- More challenge in gaining access to capital or increased pressure on company valuations
But what about the future? Where are interest rates heading?
While spending has held up well so far in this environment, the longer the combination of sticky inflation and high interest continues, the greater pressure consumer spending will come under and therefore an increase in the chance this will start to impact more sectors numbers.
For B2B spaces, many have tightened up their spending as a precaution (with perhaps the exception being areas of transformation and known high ROI initiatives), as well as headcount reductions impacting seat numbers for areas for SaaS.
One way you can assess where interest rates are likely to be next year is to look at predictive markets, as well as listen to the steer that central banks are setting about the direction of travel they anticipate.
Predictive markets are where experts bet on outcomes based on their available knowledge, this plays into the concept of “the power of the crowd” a phenomenon where the more people that are involved in assessing an outcome, the more accurate the estimate becomes.
So what does the data tell us?
This data suggests that the expectation is that interest rates will likely stay higher, for longer than previously anticipated. With a 75% chance they will remain above 5% by mid next year, and 80% chance of staying above 4.5% by the end of 2024. Additionally with a 40%+ chance of further rate rises from here, most likely early in 2024.
Other interesting insights gained from studying predictive markets
While perhaps not as directly relatable to your FP&A activities, although interesting none the less, current topic insights gained from the predictive markets at the moment suggest
- A 79% chance that the Israel & Hamas escalated conflict continues on beyond 31st October 2023
- Only a 13% chance that another nation will step in to support either side in this conflict
- 93% chance that the Ukraine & Russia conflict will continue on into next year
How about inflation?
Similar exercises can be performed on inflation, albeit are more challenging and have less availability of data. Currently, the expected direction here appear to be a tick back up of inflation into the back end of the year, triggered by heightened geopolitical issues impacting oil and other prices. Willingness from central banks to return this to sensible levels, as well as the political drive to bring this down should see inflation continue to subside into next year, unless war or other events escalate further.
Budgeting largely falls into three categories, and this is important as it impacts your approach significantly
Strategy and Target Setting
The primary objective here is to create meaningful targets for management, at appropriate levels of the organisation based on the strategy and objectives of the business. Targets should be considerate of external measures of performance, rather than solely focused on historic performance of the management team. Consider adopting benchmarks against competition, the market or industry in which you operate and be conscious of headwinds or tailwinds that exist within the economy at large, as well as the factors affecting your industry.
Forecasting & Prediction
These are areas which have significant uncertainties, as well as relying heavily on assumptions which are prone to error based on factors outside of the control of the organisation. This is an area where its useful to leverage increased data, predictive analytics and focus on a range of outcomes through scenario analysis rather than fixating on a single (inevitably incorrect) figure. Accept that you will be wrong, and think about how this will impact the below, and how you might respond as you need to pivot and change course.
Resource Allocation
Most of what is traditionally done in budgeting and forecasting is focused on this area, however this provides a false sense of security over our control. The risk in our forecast typically lies in the forecasting and prediction above, and therefore the objective in this area should be efficiency, relevance and speed of adjustment.
The other side of budgeting is resource allocation, where we are determining based on our predictions and forecasting, what level of resources we feel we have available and that we will look to distribute across the organisation to achieve objectives. This comes with a higher degree of control, and is more so internally focused and in the hands of the business.
This is also an area where often as our predictions above are wrong, we look to adjust and challenge, and therefore it is helpful to relate the allocation of resource to our predictions on a driver basis, and through thoughtful KPIs that actually measure how well we are performing from an efficiency standpoint.
In this area, you should be wary of adding unnecessary or unproductive complexity in a pursuit of accuracy. This risks slowing and weighing down your cycle times and burdening your resources, as well as making it harder to identify when factors do change, how this has impacted, without adding meaningful contribution in terms of value creation.
The context of your budget is key
Assessing growth potential solely on how the business has performed previously, or on the expectation of management of what is possible is insufficient.
As well as the impact of broader economic and geopolitical factors, an area that is sometimes overlooked is how your company is performing relative to your industry, market and competitors. This is a truer measure of performance.
Consider your revenue, KPIs and growth rates, as well as your costs and headcount metrics against market averages and key competitors. This can also act to identify suitable driver based approaches to take to your planning, rather than relying on management inputs which are subject to bias and potential budgeting games.
Data is also readily available which can support identifying headwinds and tailwinds in an industry, as well as market based growth projections, which allow you to assess penetration into addressable markets, and tell a more complete story of performance outside of the walls of the company.