Financial planning challenge

Published May 19, 2022, 4:33 AM

by Benel D. Lagua

            In the classic textbook on Corporate Finance by Brealey, Myers and Allen, they introduce the topic of financial planning by saying that a camel looks like a horse created by a committee.  “If a firm made all its financial decision piecemeal, it would end up with a financial camel. Therefore, smart financial managers consider the overall effect of financing and investment decisions and ensure that they have the financial strategies in place to support the firm’s plans for future growth.”

            Most analysis of the future begins with understanding the past as a necessary prelude. Traditional financial analysis will do both vertical and financial analysis. Vertical analysis looks at each item in the financial statement as a percentage of another item. Horizontal or trend analysis is a review of financial information over a period. The results are evaluated against the characteristics of the company, the industry and competition.

The buzzword in financial circles these days is data analytics and machine learning. Data analytics looks at what has happened over a period of time, why these things happened and what will most likely happen in the next term. Machine learning is data analysis that automates the analytical model building, usually with application of artificial intelligence.

            Although analytics has advanced greatly because of sophisticated knowledge in advanced mathematics, statistics, and software engineering, one cannot conclude it is foolproof. In fact, to rely on its results solely can lead to problematic outcomes.

            Planning through forecasts may determine the most likely outcomes. But the astute planner is also concerned with unlikely events by way of contingency. “What-if” scenarios should be developed especially in the light of today’s very volatileand uncertain environment. Who anticipated, for example, these past 2 years of pandemic considering that the last occurrence was 100 years ago?

            Even before contingency and options planning, another challenge to decision makers is the reliability of the data inputs. Often, the planning processes are fragmented and lack real time inputs from operational areas. Integrating the plans from different areas of the business which may be disconnected is a concern.

            With poor data quality, the planner will be hard pressed to transform the analysis into critical insights. This writer has been witnessing organizations suffering the inability to have a single source of truth. Consolidating the conflicting information from various sources leads to questionable insights for valid decision making.

Organizations must instill discipline in order to enforce effective collaboration across departments. Oftentimes, there are disparate and disconnected forecasts by the various teams and the central planner is tasked to put everything together.

With the fast paced changes in the environment, data must be real time and up to date. As they say, yesterday’s news is already history. Real time reports will help identify underperforming teams, improve operational efficiencies, and develop actionable plans to deliver results and desire growth. The timeliness of data also allows for fast reaction time to developments in the environment.

Another important input to planning is being aware of signals in front of decision-maker. These signals need not be related to the past but are portends of the near future. In a recent TV series that touches on weather forecasting, an episode starts with signals. “Signals are simple. Sometimes they are sound, sometimes they are colors, sometimes they are vibrations.”

In planning, the decision makers look at external variables with a keen eye. As in weather forecasting, our visibility is easily blocked, narrowed and distorted by external factors. There are both leading and lagging indicators. Business, economic and industry cycles must be analyzed well. One approach is the PESTEL analysis that evaluates the external forces that can impact an industry and gauges the future market potential for the growth or decline of a product or firm. PESTEL considers the political arena, economic factors, societal changes, technological development, the changing environment and the legal milieu.

Finally, the process that produces the plan is as important as the plan itself. Planning forces consideration of the interaction of financing, investment, capital structure and working capital decisions of the firm. Planning prepares the organization to reset when unlikely or unanticipated events happen. As one expert said, “if you fail to plan, you are actually planning to fail.”  We plan not to avoid risk, but to ensure we are taking calculated risks that will deliver the desired outcomes.

(Benel Dela Paz Lagua was previously Executive Vice President and Chief DevelopmentOfficer at the Development Bank of the Philippines.  He is an active FINEX member and an advocate of risk-based lending for SMEs.  The views expressed herein are his own and does not necessarily reflect the opinion of his office as well as FINEX.)

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