2020 is drawing to an end, but many financial budgets don’t follow the calendar year, so some finance leaders must still decide how best to budget and plan amid ongoing uncertainty, and given that the COVID-19 pandemic and its effects may have distorted typical budget baselines.
“It’s very likely that CFOs will need to change some typical practices in cost structure, assumption validation, and how they use data and indicators,” says Faith Vakil, Director, Research, Gartner. “A typical budget baseline based on recent ‘actuals’ performance alone is no longer useful.”
Take a three-pronged approach to building a base budget for FY21 to maintain funding for important initiatives
Many finance leaders have deployed or considered zero-based budgeting (ZBB) for some or all of their budgets for 2021, because ZBB starts with an empty spreadsheet, instead of just assuming that previous expenses will be maintained.
Moreover, many of the early actions already taken by CFOs in response to pandemic budget pressures were the kinds of cost measures identified in zero-based budgeting. But even when using zero-based budgeting, it’s still difficult to pick a single, credible baseline budget for FY21.
Gartner recommends that finance leaders take a three-pronged approach to building a base budget for FY21 to maintain funding for important initiatives and ensure that opportunities aren’t missed or mistimed when costs and investments are cut or added.
Action No. 1: Protect costs that differentiate the organization from competitors
Instead of traditional accounting- or revenue-based cost structure models, you can categorize costs to protect those that are unique to what differentiates the organization from competitors, ensuring the organization can still achieve long-term value despite the effects of COVID-19.
To determine the major points of differentiation, ask:
- What are the common themes in our strategy, year after year?
- What about our company could not be readily replicated by a deep-pocketed competitor?
- Why do customers give money to us and not someone else in our space?
Pinpoint the unique costs tied to differentiation — separating them from the enabling costs
Then identify three to five strategically important initiatives that are currently planned or in progress and decide which has the most potential to further the points of differentiation you just identified.
Pinpoint the unique costs tied to differentiation — separating them from the enabling costs that support competitive outcomes and the commoditizing costs that are typically incurred by any competitor in the space.
This exercise helps when formulating the baseline for the FY21 budget to ensure the seeds of future revenue are protected from otherwise necessary cost-cutting exercises.
Action No. 2: Pressure-test bottom-up assumptions and budget submissions
Companies typically rely on current year actual performance to start building assumptions for the next fiscal year, but COVID-19 has compromised that capability. Moreover, the typical approach of validating budget assumptions by using external sources, market data and macroeconomic outlooks are currently less helpful due to the unique ways in which the pandemic has impacted each company and industry sector.
It is likely that revenue assumptions based on FY20 are highly conservative due to the rampant uncertainty and potential risk factors
The most straightforward solution to validating baseline budget assumptions is to revisit them more frequently to test whether they need to be updated. Add more rigor to this approach by closely monitoring business-unit work on bottom-up assumptions instead of imposing top-down assumptions from a central finance function.
Using analysis performed by those closest to the customer or marketplace is likely to produce the most credible set of assumptions when external assumption validation is not helpful due to ongoing disruption.
Action No. 3: Triangulate data and indicators within the organization
It is likely that revenue assumptions based on FY20 are highly conservative due to the rampant uncertainty and potential risk factors underlying downside scenarios relevant to the time. Finance leaders should seek to ascertain how their downside forecasts compare to actuals so far this year before using them to plan for FY21.
Gather the following information and compare it with downside forecasts to inform discussions and forecasts for FY21:
- Demand and sales forecasts from regional sales teams and line-level business units
- Internal daily and weekly sales reports across all regions, distribution channels and product categories
- External reporting on industry trends
Use this information to assess whether top-down revenue assumptions are too conservative. Further, use “triangulated” analysis like this to make the case for moderating initial downside scenarios during discussions with the executive team.