Uncertainty
Allowances: How CFOs Can Prepare For The Unexpected
By
Jim DeLoach, Former Andersen Partner and currently a
Managing Director at Protiviti
The
interconnected disruptions roiling markets and industries today confront
boards, CEOs and CFOs with more possible futures than they have ever had to
consider. CFOs contending with uncertainties that resemble sci-fi plotlines
(war, climate change, natural disasters, nuclear saber-rattling, beached
container ships) are trending toward the approach that makes the most sense:
Allow for the unexpected and prepare the organization for the most likely and
extreme 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
These
risks—persistently high inflation, soaring interest rates, fears of recession,
talent shortages, energy crises, climbing wages, regional conflicts, reshoring,
near-shoring, friend-shoring and more—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 and extreme 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 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 strive to exit it in a strong position conducive to growth.
Supply
chain
As
CFOs run through scenarios with supply chain leaders, they should identify and
measure risk across all operations and regions. They also should assess risk
across different time dimensions—current risks as well as those likely to pose
challenges to short- and long-term operations based on the organization’s
strategic direction. The plans developed to address these scenarios should not
overemphasize cost factors; instead, costs should be evaluated and monitored in
conjunction with supply chain reliability, resiliency and responsiveness.
Talent
Hiring
freezes, reductions in force, compensation adjustments, reassignments and other
people-related changes should be planned and executed with surgical precision
and empathy amid a long-term talent shortage and challenges to attract and
retain needed skills. CFOs should work
closely with their chief human resources officers to ensure that talent
strategy aligns with business strategy and that data-driven talent assessments
and skills inventories are conducted semi-annually (or, better yet, quarterly)
to identify and eliminate gaps that impede the achievement of business
objectives. These skills inventories provide critical decision-making insights
when reductions in force are needed and/or when difficult-to-source skills
become available (due to less surgical layoffs by other companies) while also
ensuring that sufficient resources are in place to pivot back to growth mode
faster than the competition.
These
three areas cover only a portion of the scope of a comprehensive contingency
plan, but they represent a great start. An effective plan prioritizes,
sequences and groups actionable steps by function and operating unit to
establish clear ownership, authorities and accountabilities via key metrics
that are managed against specified targets. Once the plan is completed, it
should be reviewed and approved by the CEO and board of directors. Moreover,
management should review the plan periodically—annually, at least—to ensure it
remains current, and test its underlying assumptions, before finally briefing
the board following such reviews.
The
future cannot be prevented and remains uncertain, but CFOs can prepare the
organization to be resilient when it arrives.
Check out Jim’s website.