George would like to thank Philip Peck from Palladium Group, Inc. for his helpful input to this column.

In last month's column, I introduced the third leg of the strategy execution model, resource allocation. I discussed the limitations of the traditional budget and introduced driver-based planning as the beginnings of a better method. This month's column will build upon this foundation of driver models and introduce cause-and-effect performance analysis and rolling forecasts as complementary enablers in support of better resource allocation.

Traditional budgeting emphasizes the reporting of actual results and the analysis of actual variances to the budget. It is intentionally backward looking and addresses only what happened, not why. As a result, traditional variance analysis offers no help in ensuring that the organization will repeat and enhance its successes or minimize its failures. A 2005 study by the IBM Institute for Business Value shows that this ineffectiveness is widely felt; only 42 percent of CFOs surveyed believe that their finance department measures and monitors business performance effectively.1 In fact, traditional planning focuses on minimizing deviation from the original budget - not on deciphering the underlying performance drivers in order to proactively take measures that can boost competitiveness and foster the execution of strategy.

Figure 1 illustrates the variance review process, causal analysis and action planning for the hypothetical call center we introduced in last month's column. Where traditional budgeting would focus on the single line item of "salary expense" and note that it is over plan, driver-based causal analysis examines the assumptions about the drivers on which the original plan or forecast is based. You can see that the number of inbound calls received by the center is substantially greater than the plan estimate and that the actual agent capacity is significantly below the plan estimate. These business drivers work in concert to generate a higher-than-expected labor expense for the call center.


Figure 1: Call Center Variance Review, Causal Analysis and Action Planning


Using this knowledge, managers can investigate the causes underlying the unexpected call volume increase and the poor agent productivity. Because the key assumptions are exposed, managers can more readily identify incorrect assumptions and work together to develop corrective action plans. This explicit focus on operational drivers shifts the dialog from broad financial observations to a discussion about the internal as well as external factors influencing performance.

Rolling Forecasts

In traditional planning, budgeting is a discrete, annual event. This large-scale one-time planning exercise is sometimes complemented by a midyear financial reforecast of the current year to validate if the plan will be met. Few organizations, however, consistently maintain a rolling view of future performance. Instead, they are fixated on the near-term performance of the current year. This nearsightedness comes at the expense of long-term strategic goals and fundamental strategy execution.

A rolling forecast, built upon driver-based planning models, provides a continuous performance outlook beyond the current year, generally five to six quarters from the present quarter. As one traverses this time frame, the forecast becomes less precise, giving a more directional indication of performance. Rolling forecasts typically include less financial statement line-item detail than traditional forecasts or budgets and emphasize operational drivers.

Driver models are essential for successful rolling forecasts. These driver models provide the bridge between operational activities and financial outcomes. Instead of completing a detailed, bottom-up financial forecast (which closely resembles a traditional budget), the rolling forecast built from driver models focuses on the key operational drivers with the greatest impact on financial performance. This structure allows for rapid forecast cycles that provide the flexibility and timeliness necessary for more dynamic resource planning.

Because rolling forecasts are updated on a regular basis, if performance gaps appear, management can take action right away to mitigate expected shortfalls. Conversely, if performance surpasses expectations, resources can be freed up or reallocated to pursue other projects or opportunities. Many leading organizations are using rolling forecasts to improve their forecasting accuracy and operating agility while also dramatically streamlining their internal planning efforts.

In summary, our objective is to allocate resources to effectively execute our strategy. These corporate strategies include both short-term and long-term objectives. The challenge is to manage the operational levers of the business in order to consistently attain the desired short-term and long-term financial outcomes. Causal models provide this link. Together, performance analysis using causal models and forward-looking rolling forecasts provide us with the visibility to adopt a more dynamic, continuous approach to planning. Ultimately, they allow us to be smarter and take a longer view so we can more effectively allocate our resources. 

Reference:

  1. The Agile CFO: Acting on Business Insight. IBM Institute for Business Value, 2005.

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