COVID-19 has seriously tested and exposed gaping weaknesses in financial planning and analysis (FP&A) for the manufacturing sector. Predictions and models based on traditional historical data failed in the face of a massive and unique disruption. The finance and accounting departments quickly retreated and focused on cash flow forecasting to support the survival of the business – which is hugely important, but could they have done more? What lessons should we learn about how the FP&A function needs to improve for the future?
The most important lesson is the need for an integrated operational and financial model, very close to the real time of the organization. This model should be causal and reflect the reality of resources and processes for the whole organization, not just for production, and not just for financial reporting. COVID-19 has affected all parts of the organization. An important element of causal modeling is the nature or responsiveness of resource use (and associated cost streams) as a fixed, proportional relationship (or any other relationship). These definitions are controversial because they are often misunderstood and misapplied; Done correctly, they provide deep insight into marginal costs as well as profitability, and facilitate cash flow analysis. Some would argue that COVID-19 has made all costs proportional, but that is an incorrect characterization. COVID-19 has made many costs avoidable (fixed and proportional costs) that had never been considered avoidable before. The characteristics of fixed and proportional link resource use and cost to production, whether the purpose of the work is regulatory compliance, payment, or production of a product. Manufacturing has a long history of using real-time operational systems for production, but finance is generally far from integrating financial information with real-time operational systems. Technologies and methodologies are available, but the financial and accounting profession has not understood the importance of knowledge of management costs for internal decision support.
A second important lesson is the need to create causal models for customer profitability that go well beyond product cost. Customer profitability is impacted by many non-manufacturing costs associated with customer acquisition and management, such as marketing and sales costs, discounts, order size/frequency/complexity , change requests, frequency of orders and shipments, customer profitability information, etc. It’s hard to decide how to prioritize customers without this information when you have limited production capacity, as was often the case during COVID-19. In normal times, complete insights into customer profitability can greatly improve an organization’s strategic direction and profitability.
Supply chain is a third area that COVID-19 has presented as a major risk area and constraint to profitability. This has long been an area of targeted cost reduction. However, COVID-19 is redefining supply chain optimization to place greater emphasis on continuity, viability, availability, and location. Investors have been brutal in demanding improved ROI, often limiting investments, but when supply chains are taken into account, it may be time to invest seriously and even integrate vertically.
The overarching lesson from COVID-19 is the need for continuous, causal and agile operational and financial planning, including contingency planning for severe global events. Government agencies and the military are constantly planning, training or playing for extraordinary contingencies – these involve the initial response and the ability to sustain a sustained response. Although manufacturing companies are not in the business of emergency response, they must be economically resilient, which means planning to maintain an economically viable level of production and sales. Financial planning and analysis performed with a strong knowledge of operational needs and a causal model of economic realities can be a competitive advantage for a business. Expanding FP&A capabilities beyond external financial reporting results by developing more robust models for internal decision support and operational systems integration is a top priority and a critical first step. The Institute of Management Accounting’s Profitability Analysis Framework and Conceptual Framework for Management Cost Statements on Management Accounting, a new Center of Excellence in Profitability Analysis and the Institute of Management Accounting resource consumption offer insights and guidance to improve FP&A operational and causal guidance and modeling for internal decision support.