9 minute read
Financial planning
A lighthouse in the storm
We ask how businesses can offset the effects of inflation by using AI-based scenario planning.
Global inflation has its grip on the world economy as organisations learn to adjust to its impact on business performance. Fast action and decisiveness are in order to remain afloat among geopolitical tensions, the resulting supply chain disruption and increasing market uncertainty. It is an interesting time to be an accountant today – a role that can be a lighthouse in the storm.
The financial planning and analysis (FP&A) landscape has notably changed over the last few years due to many challenges, including a global pandemic, energy crises, climate change, cyberattacks and remote work. In addition, a rapid rise in prices and interest rates that began in 2022 has continued to garner international concern and action. In many countries, inflation has reached 40 year highs, and energy and food prices have seen the biggest price increases.
In the United Kingdom specifically, inflation reached double digits by September 2022. In mid-October, Prime Minister Liz Truss resigned after just six weeks in office amongst market turmoil and a failed tax-cutting budget. Meanwhile, the consumer market continues to react, with the Consumer Prices Index (CPI) surging to 10.1% within a 12 month span from last September. A large price increase in food and non-alcoholic beverages, as well as furniture and household goods, contributed to this surge. These numbers indicate that the cost of living and covering basic needs have consumers tightening their wallets for other purchases. What does this mean for business? And what can organisations do to offset this trend?
It starts with scenario planning. But first, let’s look at what inflation is and how to adapt to it.
The inflationary environment
The roots of inflation have many origins, but the common thread lies in a decrease in supply or an increase in demand that results in higher prices that eventually bring supply and demand back into equilibrium. In recent years, price increases have been tied back to supply chain disruption, a reduction in oil production and other energy-related factors. In order to have a clearer understanding of inflation and the ways in which to adapt to the circumstances, finance professionals can keep three things in mind.
1. While inflation is a global issue, its impact and rates can vary by country
Inflation rates have differed substantially by country, discrepancies that highlight the complexity of inflation, and the importance of developing a strategy for planning and managing in an inflationary environment. In Japan, for instance, inflation reached only 3%, which was an eight year high for the country, while the UK’s rate has reached double digits.
2. Multiple indexes help measure inflation, and each provides unique insights
According to the eurozone Harmonised Index of Consumer Prices, the industry-specific inflation rate ranges from -0.8% for education to 19.7% for housing, electricity and gas. When finance professionals determine which index and forecast to rely on for planning, it is important to understand what each index includes in its calculations, and which indexes are most relevant and appropriate to use for a particular organisation.
3. Inflation affects industries differently
Finance professionals are required to understand how inflation affects respective industries, the current inputs and the assumptions that can be used to model it over the coming months and years. According to one report, the manufacturing industry has been one of the hardest hit sectors in terms of inflation (see bit.ly/3OgY5EQ). Supply chain disruption, labour shortages and logistical planning all contribute to the industry’s challenges.
A threefold approach to inflation adaptation
FP&A professionals can adapt to an inflationary environment in three powerful ways: business partnering, predictive planning technology and finally, sensitivity analysis and scenario planning.
1. Business partnering
Economic uncertainty and business partnering are intertwined: the higher the uncertainty, the greater the need for closer partnering between FP&A professionals and the broader business. FP&A professionals have the chance to embrace their role as strategic advisors to their organisations, a role that requires consistent and meaningful interaction with people across all departments. F
P&A professionals are not just on the receiving end of data, but rather have the ability to co-create strategies for both managing and planning for the characteristic volatility of our current environment. As business partners, they can seek opportunities to increase revenue and/or reduce expenses such as:
● Product portfolio: examine the entire portfolio and seek opportunities to remove unprofitable products, bundle products as a way to increase revenues and increase prices.
● Expenses: consider a zero-based budgeting process and require the business to review and justify all expenses.
● Working capital: work closely with treasury to develop cash management strategies that maximise working capital.
2. Predictive planning technology
With the ever-increasing need to include external drivers, sensitivity analysis and a review of multiple different scenarios, the need for digital transformation in financial planning is more important than ever. According to the FP&A Trends Survey 2022, respondents who utilised technology were happier with the forecast than those who did not. Only 39% of respondents rated forecast satisfaction as either good or great; however, the number jumped to 50% for organisations using a cloud-based planning tool and 63% for those using artificial intelligence (AI) as part of the planning process.
According to a recent BARC topical survey, the use of predictive planning is skyrocketing. One in four organisations already use predictive algorithms and machine learning productively to produce their plans and forecasts in less time, with less effort and with better and more accurate results (see bit.ly/3TK0b1k). Key findings from the survey include the following:
● 94% of users already benefit, or expect to benefit, from predictive planning technology.
● Productive use of predictive planning technology in corporate planning has increased nearly sevenfold in two years, from 4% in 2020 to 27% in 2022. 64% of users increase quality and accuracy of forecasts with predictive planning technology.
● 1% of organisations have failed at using predictive planning technology.
Companies that embrace predictive planning and AI technology can have a more robust and complete planning process. Technology alone will not magically make an existing plan more accurate, but it does provide organisations with a better ability to receive greater insights into drivers of KPIs and to use these drivers more accurately. Technology allows for finance professionals to import external data such as commodities pricing fluctuations to build databacked plans that inform confident decisions. A robust cloud-based planning tool can make it easier to collaborate across the business, implement external drivers, use AI and machine learning to illuminate trends, alerts and opportunities, and compare business scenarios.
Despite the opportunities that predictive planning and AI technology offer to finance professionals, misconceptions still abound. AI is a mature technology that takes the heavy lifting out of data management. Automation replaces manual tasks, which frees up valuable time, resources and focus for finance professionals to concentrate on more strategic tasks.
3. Sensitivity analysis and scenario planning
Much like an allergy test that examines how the skin responds to various elements, sensitivity analysis is a process that takes a key input and sees how a key driver changes because of that input. It is based on what-if scenarios that determine what would happen under particular circumstances. An example of a sensitivity analysis is taking the cost of lumber and seeing the impact on a building contractor’s overall profitability at different lumber cost points.
Running a sensitivity analysis on key drivers and inputs can help FP&A professionals determine how each driver and input will affect the overall financial health of the organisation. One way to start is by taking the top three to five expense drivers and running a sensitivity analysis on each of the inputs to see how rising costs will affect overall financial health. Doing this will help to determine when an organisation may need to raise more cash or increase prices to ensure its overall wellbeing and financial health.
Stasis in the world of finance is a death sentence today. A static budget with only a single point estimate won’t cut the mustard in today’s rapidly changing environment, and the need to run multiple scenarios is more important than ever. Every organisation has to build its planning focus around multiple scenarios that could occur in the coming months and years.
Every organisation needs to ask itself: what will we do if inflation stays stubbornly high for the next two to three years? What will we do if the global economy heads into a major recession? These questions are the first step in modelling and planning for potential scenarios.
Technology as a talent magnet
Smart organisations attract smart talent, and in today’s talent environment, it is absolutely critical to think of technology as a talent lever. According to a study by Future Forum, embracing digital tools is a key component in building connections with employees (see bit.ly/3UMnIzR). It is clear that there is a relationship between innovative companies and higher degrees of employee engagement, experience and satisfaction.
Consistent with quarter-over-quarter findings, people who work at companies they consider technology innovators continue to show higher employee experience scores in all categories, including 1.5x higher scores on productivity, 2x higher scores on a sense of belonging, and 2.5x higher scores on overall satisfaction.
Smart businesses equip their employees with powerful planning tools. Those that do not will risk losing or not attracting the best talent at all. All finance professionals want to be positioned for success, and to be successful they need to be equipped with advanced planning tools. Providing the right solutions to do that will increase the likelihood of employee engagement for everyone.
Summary
FP&A professionals can help the business manage an inflationary environment by incorporating business partnering, predictive planning technology, and sensitivity analysis and scenario planning in their planning processes moving forward.
The opportunity for FP&A professionals to make a real impact on their organisations has increased during these times of uncertainty. Adapting to this changing environment allows the finance organisation to continue evolving from a back-office function to that of a value-added strategic partner. Technology can help finance professionals be equipped for stormy weather in order to maintain not only the balance sheet, but organisational balance too.
