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Being part of No. of Budgeting projects in South  East Asia, one of the common business requirements of Group finance/CFO is simulation of Annual Budgets

 

Typically the Annual Budgeting process is done based on certain Key assumptions like Forex Rates, Inflation, Prices, Borrowing or Interest Rates. The detail operational budgets like Sales, CAPEX, Cost & Operating expenses are planned based on this assumption which integrates to Financial Plan. 

 

Let us look at following scenarios:

 

  • A Oil & Gas entity makes an assumption for budgeting around the Crude Prices and Interest Rates
  • A manufacturing industry makes an assumption of its Key Raw material price or Usage
  • A CPG industry makes an assumption of its SKU price

   

 

Now given the dynamics of economy and market conditions the CFO or group finance wants to do real time simulation around the budget based on the fluctuations in the Key parameters and analyze the impact of these changes on the budget financials within the matter of minutes

 

Following are the challenge(s) with this approach:

 

  •  The changes in Key parameters has impact on the operational Budget which in turn affects the financials, most of the time our Group Finance/CFO do not really own this part of the Budgeting process hence face a challenge of linking the Key Parameter change to Operational budgets – which is mostly done outside any system

 

Given this challenge there could be following approaches:

 

  • Automate the derivation of operational budgets based on the Key Parameters identified. The down side of this is the derivation of operational budget will be too complex from the key assumptions
  • Have a separate model for simulation of the Budget which is an approximation of Actual Budget to give group finance a ball park analysis of the impact on the financials. This is how closely we  can get to the Budget simulation process

   

Let this blog be the starting point of sharing your experiences around the Simulation of Planning (Budgeting/Forecasting) process.

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4 Comments

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  1. Hussain Sehorewala
    Besides the key factor In reality there are so many aspects that will affect Budget. Things such as key resource leaving the project, unforeseen technical challenge etc. This factor are taken care by keeping some buffer in the timeline.

    We need a prediction system that not only considers external financial factors, but also your actual project execution data and simulates the project budge. By project execution data I mean stuff such as delay in phase of project or less resource then needed.
    Probably we need a Watson to do this job 😉

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  2. Samir Neji
    An integrated Planning concept had emerged by 2005+, Wwhich SAP killed with some SQL drama in between, It is getting back on road; the last decade of Account based process will die. Your blog is very contextual to that and hence it has to be discussed more and more. It will tell you the men from boys around.

    My take is more of a foolish prediction, which should be realised in the next 2-3 years:-

    1. Re-forecasting on changed variables should be done bottom up as a single model. (told you, I am a fool). 
    2. Insist that it should not be designed as multiple models as it did not work in the past, hence you suggested simplified Financial models in your blog, which is the practice today. I feel that it has failed to support an enterprise level model.  
    3. Item 1 will need structured master data and hence I will suggest that the simulation of this nature should be done with BAPI running from Planning system to Execution system (ECC). I should be able to map Plan master data to actual master data with an easy mapping tool in planning system.
    4. We should reuse master data from ECC as we will need master data changes and Config to do the second level of simulation.
    5. Innovating Item 4, make it simpler and easier it should be a must and that is a challenge we should address with EPM 10 and forward.
    6. the next version of In-memory should emerge and should help us to make it simpler and easier to do item 1 with item 4. 
    7. Now, my question nack to you is
    Will Planning head back to Transactional system as an application on top of execution process? If yes, By when? What do you need for that?? Our customer need it and we need to crack this complexity?

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  3. Muthu Ranganathan
    Umesh,

    Welcome to blogging on SCN and good to see you share some practical thoughts on how simulation works.

    essentially the industry term used for simulation is ‘Driver based planning’, where operational drivers drive plans, or the rolling forecast can be modified based on changes in the drivers (assumptions).

    You are right in saying that companies would like to keep the budgets separate from these simulations. Budgets becomes the annual plan that a company would like to create and monitor. But they would like to have a more practical version on top of that, that makes adjustments for different drivers, and shows up a a certain realistic picture of what the business is going to look at. This is often the operational drivers such as sales mix, volumes, rate cards, employee ratios, other cost elements etc. etc. This is often done as a forecast version.

    Many best practice companies are even looking at Beyond budgeting, to make the full budgeting as simulation driven – check out the http://www.bbrt.org to understand what the Beyond budgeting round table talks about continous planning, key need for CFOs and Finance P&A folks

    regards
    Muthu Ranganathan
    (follow me on twitter : @muthurangnathan)

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  4. LOKESH NANDULA
    Good to see your blog Umesh.

    Assumptions are required for any planning/ forecasting process and will help us to understand the projected ROI or NPV to make vital business decisions. Simulation is helping the business to understand the gravity of risk associated in achieving the targets. If we can integrate Risk into planning/ budgeting/ forecasting then we will be close to reality.

    Changing external factors will influence risk and hence risk need to be re-evaluated. We need a separate tool to prioritize risks based on impact and occurrence. Then integrate the risk management tool with BPF tool for simulation.

    I think, SAP is in the right direction by integrating GRC and BPC. In 5 years from now, Planning/ Budgeting/ Forecasting will be meaningless if it’s not Risk-Adjusted.

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