Uncertainty Allowances: How CFOs Can Prepare For The Unexpected
Uncertainty allowances: How CFOs can prepare for the unexpected getty “People ask me to predict the future,” science fiction legend Ray Bradbury wrote, “when all I want to do is prevent it. Better yet, build it.” For CFOs contending with uncertainties that resemble sci-fi plotlines (war, climate change, natural disasters, nuclear saber-rattling, beached container ships), there’s an even better approach: Allow for the unexpected and prepare the organization for the most probable of those futures. Doing so involves a combination of financial planning and analysis (FP&A) together with contingency planning—competencies that reside squarely in the CFO’s increasingly sophisticated wheelhouse. An uncertain landscape presents an unclear future with multiple scenarios—so lean on FP&A The interconnected disruptions roiling markets and industries today—stubbornly high inflation, soaring interest rates, fears of recession, talent shortages, energy crises, climbing wages, regional conflicts, reshoring, near-shoring, friend-shoring and more—confront boards, CEOs and CFOs with more possible futures than they have ever had to consider. These risks require finance leaders to develop “uncertainty allowances” by identifying possible alternative futures and preparing different plans to exploit the upsides and manage the downsides of the most plausible scenarios. Conducting this assessment requires CFOs to lead data-driven contingency planning activities across numerous domains, including strategy-setting and execution, capital expenditures, supply chain risk management, and human capital management. A fully integrated FP&A capability equips finance leaders with the data inputs they need from across the enterprise as well as relevant external sources (economic and marketplace trends and indicators) to produce and update rolling forecasts , dynamic cash flow plans , and scenario-driven assessments of the impact of changes in various economic and other market assumptions and emergence of various risks on the business. Allowing for all potential future challenges requires organizations to be flexible as they focus on the fundamentals and optimize their most promising revenue-generation opportunities while being prepared to shelve moonshot projects. One key, of course, is validating data quality and integrity. Cross-functional collaboration ensures that all data feeding into FP&A are appropriate. Relevant inputs and robust analyses produce better scenarios and forecasts as well as more robust plans for adjusting to those future conditions. Knowledge is also king for finance groups, which need to identify and access data inputs that shed light on expenses and revenues related to supply chain and procurement, manufacturing, service lines, talent management, marketing, IT, treasury/cost of capital, and the rest of the business. In addition, regardless of whether the FP&A function is centralized or decentralized, it should be regarded by the business as credible, collaborative and communicative. Prioritize cost optimization over cuts Two other points are important to keep in mind when leveraging finance-led forecasts and scenarios to develop contingency plans. First, while many contingencies involve cost reductions, it is often more profitable to prioritize cost optimization over cuts. For example, rather than a broad objective to reduce purchasing activity by 10%, there may be more valuable opportunities to optimize procurement costs by making changes to sourcing, planning and/or supplier negotiations that yield similar and systemic structural savings without impeding the business areas that use those purchases to generate revenue. Second, finance groups should develop a hierarchy for cost optimization initiatives. The plan should offer a menu of cost-saving steps that can be implemented as a possible future scenario (e.g., a severe recession) materializes, with targeted cost savings in the current and subsequent projection periods. Each initiative should be prioritized to create a scalable plan. Depending on the severity of the scenario or scenarios that materialize, some or all of the steps may be implemented. Preparation breeds resilience: three key areas of focus While contingency plans should be comprehensive, the following areas are great places for CFOs to focus their foundational work to help their organizations enhance resiliency by preparing for the unexpected: Capex —As finance groups plan for contingencies affecting capital expenditures, they should focus on product and service lines likely to prove most resilient in each scenario, as well as revenue opportunities, payback periods, carrying costs and adjusted targeted rates of return. The CFO is responsible for determining what it costs to execute both short- and long-term strategic objectives, as well as the opportunity costs associated with delaying or permanently shelving capex investments. This determination can be of vital importance given the need for many companies to stay the course in modernizing their legacy technology infrastructures and investing in digital capabilities to stay connected with and continuously improve the customer experience. So if a severe downturn were to occur, the company should […]
