By Nilly Essaides, Sherri Liao and Gilles Bonelli, The Hackett Group

The economic consequences of the coronavirus outbreak vary by country and company, but one common factor is that most financial planning and analysis (FP&A) teams have had to go back to the drawing board to revise their forecasting process and update scenario plans. The unprecedented level of disruption in business conditions compels FP&A to abandon their traditional, tedious, bottom-up forecasting processes to produce forward-looking insights faster and more frequently. To accomplish this, FP&A should deploy high-level, cross-functional teams that, by working with a small number of KPIs, can assess how different scenarios are playing out in the market and recalibrate the business outlook.

Forecasting at the speed of change

The human and economic devastation caused by the rapid spread of Covid-19 upended budgets and rendered performance targets obsolete. At most companies, even worst-case scenarios did not account for an event of this magnitude – and for some, their very survival is on the line.

Under normal conditions, forecasting and scenario planning are distinct activities. Forecasting is about understanding where the business is landing compared to expectations (monthly, quarterly or on a rolling basis); scenario planning considers what could happen to the organization given one or more material changes in the business environment. At present, the line between the two is blurring as circumstances can change so fast that it is no longer possible to create a forecast based on past data. In addition, scenario plans must be reviewed frequently to ascertain which are becoming more likely.

Consequently, FP&A teams must exchange their traditional bottom-up, granular approach with a top-down, high-level methodology and conduct the forecast more frequently – but few are set up to accommodate this new process. More often, forecasting involves an all-consuming effort to collect data from business units and functions. To enable a more rapid response, FP&A should assemble a senior-level, cross-functional “SWAT” team with the mandate to review a limited number of KPIs (five to six, at most) in order to build a forecast that can be altered quickly as trigger events validate or disprove scenario plans.

This small team of experts can triage activities effectively while assigning specific areas of responsibility to more junior staff, such as forecasting working capital or discretionary spending. These specialists should work with a set of more granular KPIs. So, while the SWAT team may use a single cash metric, the working-capital team would dive deeper into DSO, DPO and inventory levels.

The first step is to alter the forecasting process, and the next is to adjust the feedback loop created through the management review meeting. Typically, these meetings focus mostly on BU-by-BU, actual-to-forecast and actual-to-budget variance analysis, using historical data. However, for many organizations – particularly those that have experienced a major reset of market demand and ongoing operations – spending time looking back at low-level comparative narratives is unproductive.

Instead, management should spend the bulk of its time reviewing the company’s best-case, minimum-viability and worst-case scenarios to determine which one seems to be playing out. To make sure planners target the right activities, management must ask the right questions: not how the company performed versus budget, but how conditions have changed and how that affects the forecast for emerging supply and demand scenarios.

A revised approach to identifying scenarios

For planning purposes, most companies develop three scenarios: base, best and worst. Given the nature of the Covid-19 crisis, a revised set of scenarios is needed:

1. Best-case scenario: The best-case scenario should be anchored within tested hypotheses and initially focus on an assessment of demand conditions and capacity constraints. Current data may be mostly qualitative, but it should include insights gleaned from other countries and regions, particularly those exhibiting early signs of recovery.
2. Minimum-viability scenario: This is the “new” base for companies hard-hit by the crisis or the scenario with minimum acceptable results to key stakeholders while remaining in business. This scenario must include a set of potential cost-reduction options in case conditions deteriorate rapidly. For instance, a minimum-viability scenario may include an X% reduction in workforce based on demand and supply projections.
3. Worst-case scenario: The coronavirus pandemic may pose an existential risk to some organizations, so FP&A teams must also develop a scenario based on the worst possible conditions, including circumstances that may put the company out of business. In this case, FP&A should identify and monitor indicators that pose the greatest threat to the company’s status as a going concern.

Digging deeper into each scenario

Each key market or country or region should be categorized according to a variety of possible GDP growth scenarios.

A U-shaped recovery assumes the fastest rebound in key countries where GDP quickly reaches or nears pre-Covid-19 levels. These will be geographies where evidence of fast, effective control of the virus’s spread is combined with a strong policy response to prevent structural damage to the area’s economy.

A W-shaped recovery assumes a quick, partial recovery followed by a second wave decline in GDP in key countries or regions. These will be cases where evidence of fast, effective control of the virus’s spread is not accompanied by a strong policy response to prevent structural damage to the national economy.

An L-shaped recovery assumes that there will be no rebound in GDP. These will be countries or regions where there is no evidence of effective control of the virus’s spread.

The team should identify specific actions to be taken under each scenario so that management can act as economic conditions unfold. Additionally, FP&A must determine how changes in the environment may affect the company’s commercial and SG&A functions. Further, the trajectory of GDP will vary, driven by the public health and economic response of each country or region. Both inputs will be critical as companies determine how to proceed.

Due to the interdependence of different markets, it is important to consider elements of each in the entire strategic portfolio’s value chain. If a component of the value chain in any strategic portfolio is reliant on activities taking place in countries where a U-shape recovery is expected, then this component should attract more investment compared to those in countries where a slower recovery is likely.

If a component of the value chain in any strategic portfolio is reliant on activities taking place in countries where a W-shape recovery is expected, then investment in this component should be maintained. Accordingly, if a component of the value chain is directed to markets in countries where an L-shape recovery is expected, consider gradually divesting from the portfolio and phasing out related activities.

A catalyst for change

Covid-19 has underscored the discrepancy in planning and analytics capability between top-performing and typical peer-group FP&A organizations. The Hackett Group’s 2018 EPM Performance Study revealed that top-performing FP&A organizations have invested more in technology, which has enabled them to run more analysis and deliver reporting faster and more efficiently. Of top performers, 67% have implemented a primary financial planning and forecasting system to consolidate corporate and country, region or BU information.

Consequently, top-performing teams complete the forecast 3.5 times faster than the peer group and are twice as accurate. These capabilities are essential, as FP&A must provide information more quickly to help make operational decisions. Further, top performers have automated more of their data collection processes and use a standard set of data definitions across categories 92% of the time. This means their staff spend 44% more time analyzing data than collecting it, meaning that the team can redirect capacity to focus on Covid-19-driven demands for information and analysis.

While adoption of rolling forecasts remains generally low, top performers are 55% more likely to have done so than the peer group. Consequently, they can transition more easily from a fixed budget to planning based on a dynamic forecast. Additionally, one-third of forecasts among this group already rely on cross-functional collaboration, almost double the rate of the peer group.

Planning in the age of Covid-19

The coronavirus pandemic’s immediate and long-term repercussions will have a lasting effect on the way organizations plan and forecast, as well as how they approach scenario analysis. Early in the crisis, most FP&A teams had to scramble to adjust forecasting cadence, redraw scenarios, identify new KPIs and establish cross-functional emergency action teams. In contrast, FP&A top performers were able to adjust their existing processes relatively easily.

As companies start to shift from crisis mode to operationalizing changes required by the pandemic, post-crisis scenarios are starting to take shape. Expectations are for a prolonged period of uncertainty and a second wave of infections this fall, however, which makes it imperative that FP&A organizations update their approach to scenario planning immediately.