Nilly Essaides, Director & Practice Lead, Financial Planning & Analysis, AFP
Financial planning and analysis (FP&A) faces a fast-changing business environment, as well as constant push from senior management to improve the planning process. To address CFOs’ demands, more FP&A teams are incorporating driver-based modeling (DBM) into their methodology. Those are the findings of the latest AFP FP&A Guide, Driver Based Modeling and How It Works.
“One reason we see an uptick [in the use of DBM] is that companies are dealing with a lot of uncertainty and volatility,” said David Axson, managing director for CFO and enterprise value at Accenture Strategy. “Historically, companies used historic data to trend their financial budgets and forecasts. They used last year’s data to predict next year’s performance. That’s no longer sufficient. Companies need to look at activity that’s occurring now to see what’s driving financial performance in the future.”
The report includes detailed case studies of how and why companies are using DBM in their FP&A process. Here are comments from four.
Tufts Health Plan
“Driver-based modeling is understanding the key operational metrics of the business and using those to project forward the company’s cost or revenue structure,” said David Mann, director of financial planning and performance at insurer Tufts Health Plan. Mann has always relied on models to help think about the business. At Tufts, Mann relies on driver-based modeling in the forecasting and planning cycle to figure out expected revenues and manage expenses. Driver-based models are also integral to his sensitivity analysis work in areas that experience more volatility, e.g., a high-growth market or new markets. “Using driver-based modeling is particularly effective in areas of high levels of variability,” he said.
Marco’s has been using driver-based models for years, according to Jim Boswell, director of financial planning and analysis for the pizzeria chain. “What has changed is the level of sophistication driven by the available data,” he said. “I learned the more you employ driver-based modeling, the more you want to break it down into smaller and smaller chunks in the hopes of increasing accuracy.” However, Boswell cautioned companies not to dig too deep or lose their way. “It’s an art to find a balance between how detailed you get and when that detail stops adding value to the model,” he explained. “I find a good rule of thumb is to ask myself: Can I easily explain my model to someone who hasn’t been in the details like I have?”
“Driver-based modeling is linking business activity to financial performance,” said Jim Robertson, senior director of financial planning and analysis at Omnitracs LLC, a software company. Some companies add an extra step and create driver-based models that link business activity to KPIs that in turn drive financial performance. “Identifying the drivers is a basic question, i.e., where does this number come from?” Robertson said. “Then you have to start diving down to figure out the answer. You don’t stop until you see the core business activity.”
Driver-based modeling is about quantifying business activities, when building the annual plan, based on their impact on the financial statement, according to Nate Brunner, the former vice president of FP&A at Delaware North, a food services company. The model-based approach has become part of everyday life for the FP&A group. “In sports services, attendance and average per capita spending drives revenue,” said Brunner. To forecast performance, FP&A has to watch things such as the performance of the actual team. Toward the end of a season, if the team isn’t doing well, attendance could drop significantly. “The benefit of driver-based models is that they become the language in which you can talk about the business,” said Brunner. “During the annual planning process, or the quarterly review, we can talk about the drivers that are related to the business; they become the common language to talking about financial results.”
“The concept of driver-based modeling and planning is definitely not new, and in various forms has been used for quite a while,” said Philip Peck, vice president of finance transformation at Peloton. “That said, given the imperative in today’s increasingly complex and uncertain environment to deliver improved business insights, faster cycle times, enhanced ‘what if’ modeling capabilities, and for FP&A to be a true business partner, organizations are increasingly looking to adopt, systematically implement, and institutionalize driver modeling principles in their organizations,” he said.
Without these models, companies cannot become the agile organizations they need to become in order to succeed in today’s environment. “Driver models are essential to support the movement toward more dynamic planning, i.e., being faster and more agile around adjusting and modifying the plans, budgets, and forecasts using more advanced analytical techniques, and leveraging predictive models (driver models) to improve the quality and accuracy of forecast outputs,” Peck said.