Global health emergencies, sweeping monetary stimulus, and hundred-year storms used to happen, well, every 100 years or so.
Not anymore. These “black swan” events are seemingly happening with greater frequency, creating disruption in corporate boardrooms around the world as business leaders scramble to react and adapt.
This “new normal” requires adaptability, which – frankly – the traditional annual budgeting and forecasting process doesn’t provide. A ritual most businesses are familiar with, it has many advantages: business units are able to plan along the same timelines, and corporate functions can set deadlines far in advance, enabling a more predictable budgeting schedule. But as the pace of change and uncertainty ramps up, so does the calls to do things differently.
Enter rolling forecasts.
Rolling vs Traditional Forecasting
The biggest difference between a rolling forecast and traditional, annual forecasting process is that rolling forecasts are updated regularly throughout the year, while annual budgets are done once a year.
If the forecast period is 12 months, instead of counting down until the next year’s budget cycle (as is done traditionally), a rolling forecast adds another month as each month ends.
For example: At the end of January, the forecast would be updated to include January of the next year. Then, February of the next year would be added at the end of February of this year. The point is, there is always a fresh forecast for 12 months into the future, irrespective of the yearly calendar.
Companies that have implemented rolling forecasts report greater agility in responding to exogenous events and assumption changes. Rather than waiting until next year’s forecast cycle to course-correct, leadership can do so monthly.
A frustrating part of the annual budgeting ritual can be how quickly it becomes obsolete, despite the significant effort and time invested by finance and accounting teams – as we learned with the pandemic. (As if oten quipped, ‘the budget is obsolete before the ink dries.’) Moving to a rolling forecast eliminates that frustration.
Ok – you’re sold on the concept of a rolling forecast. Now what?
Start by getting “buy-in” from the C-Suite down to the analyst level. Processes that may have been in place for a decade or more need to change; alignment between all stakeholders is critical to ensure a successful changeover.
Workloads on accounting departments are likely to increase in the short term with a rolling forecast model, but this can be minimized by eliminating processes that are no longer needed. It can be an opportune time, for instance, to re-evaluate how finance teams spend their workdays, and eliminate obsolete and unnecessary work.
Employees across the organization may be resistant to such a dramatic change at first. Understanding the perspectives of all stakeholders ahead of implementation can be critical. They should understand why the organization is moving to a dynamic forecasting model, and why the long-term benefit is worth the upfront effort.
Lastly, some companies find it easier to add a rolling forecast as a complement to their annual budgets. Instead of abandoning their traditional cycle completely they add a streamlined budget review each month that allows for quick changes, making the organization more nimble. Over time, as teams slowly adapt to this monthly pace, leadership can decide if they want to phase out the annual review altogether.
Implications for Capex Planning
Large capital outlays have traditionally been reserved for annual budget reviews, forcing project teams to wait until the appropriate time in the year to make a proposal. By that time, the opportunity they were seeking to exploit may have passed, or the environment may have changed.
To stay competitive, companies on the cutting edge are looking to review Capex proposals throughout the year, allowing those with the most merit to be considered, and funds to be deployed to those that pass strategic and ROI muster – not when the corporate calendar dictates.
In order to pull this off, these companies need a modern-day software solution that ties together portfolio planning, modeling, forecasts, and Capex approval flows. Managing these processes through Excel and email moves too slowly and lacks sufficient data governance. With Finario, for example, the planning process and approval workflows are all connected, allowing your business to pounce on opportunities as they arise.
Moreover, strong data governance is an imperative for companies to successfully switch to rolling forecasting. Without a single source of truth, leaders lose trust in existing processes, and approvals are delayed. Finario’s capital planning system establishes that source of truth by integrating actual payment information from your ERP and other systems, auto-reconciling every change to your capital plan, and capturing up-to-date forecasts between project managers.
You’re halfway through Q1, your annual capital budgeting process is done and loaded in the system; fiscal year-end reporting is wrapped up. Now you can breathe a sigh of relief, right?
Hardly! Annual budgets are typically outdated as soon they are approved. So if you need to revise forecast or make changes to operations now’s the time. Want to affect Q1 results? The clock is ticking.
If you produce any type of physical product then Capex is a material part of your financials; if you’re managing it manually via spreadsheets, the prospect of a deep dive back into projects for a Q1 forecast probably sounds like as much fun as a trip to the dentist. What’s the alternative? Rubber stamp the figures for Q1 from the annual plan? You know this is not the right answer, as it provides zero insight to running the business, and ignores possible changes to the financials.
So here’s what you should do:
Step 1.) Deploy a project-centric capital planning solution like Finario. With such a tool you build your capital budget from the bottom up, project owners entering the actual data and leadership having visibility to results in real time. Result: a central repository of projects that make up your budget and project owners have access to the details as do finance and management teams.
Step 2.) Now that we are into the new fiscal year, ask the project owners input and review their projects. After all, who is in a better position to review these projects than the owners themselves! Plus, when you break it down by owner you are only talking about a few dozen projects each person might have to review for the entire year.
Yes, if you have hundreds of projects annually this may sound like a big task, but hear me out.
You can make this easier and be more realistic at the same time. Ask project owners to only look at projects scheduled to start in Q1 and Q2, we all know projects six months out are a “best guess” anyway. All the owners need to do is verify start and end dates — and make updates as needed and the results roll through. That is the beauty of a project-centric Capex system.
Step 3.) Ask if any issues have come up that require an immediate fix. A critical machine might need replacement sooner than budgeted, a roof might have just started leaking, or a new safety update may be needed. The people that know this detail best are users in the field. Just be sure you are pulling forward any projects that have become critical or enter any new safety/regulatory projects that are now mandatory but were not in the budget.
Step 4.) After input from the field comes Finance’s review. This is where an experienced financial eye looks over the changes, assesses impacts, makes sure nothing was keyed in error (don’t want to create any false alarms with leadership), and performs a general “smell test” of the Q1 forecast. It’s the time to check that current projects are incurring actual costs and are inline with estimates via standard reporting from your integrated Capex solution. If a project looks like it’s going over budget make sure the Q1 forecast reflects that change. It’s also time to question owners about projects that are supposed to be in progress but have no costs coming through; if the project is delayed then work with the owner to establish a realistic start date.
That’s all there is to it. Leadership now has an updated, realistic Q1 forecast of Capex spend. You will want to compare this to the original budget, which Finario also makes a snap, and discuss any material changes. But that is the entire purpose of this exercise: to find and review issues that may impact quarterly and annual results.
Moreover, with a project-centric planning and management tool, you are able to add insight to the capital budgeting and forecast process. Suddenly, getting updates on hundreds of projects is realistic and manageable. Your process has gone from “another spreadsheet nightmare” to a “review and assessment of impacts on financial performance.”
Which one sounds like a better use of time and effort?
Most companies would agree that the objective of making smart capital budgeting decisions is to ultimately acquire assets that are worth more than they cost.
While the process of making those decisions can vary dramatically from one company to the next, there may be near-universal agreement that said process should be easier and more effective.
You’re not alone if you’ve been budgeting Capex via email and spreadsheets in various formats and with differing levels of detail. Or, if you have an enterprise performance management (EPM) solution that does what it’s supposed to, but really can’t handle the nuances and requirements of capital planning.
You know the “pain.” It comes from consolidating detail, making a summary, comparing requests to historical data, distributing the consolidated budget, tracking changes, rolling in updates, and redistributing docs — multiple times.
Fortunately, there is a better way. Which is why it pays to know “what’s out there and what you should expect from a mature, purpose-built Capex software solution?”
To begin to answer that question, let’s start with the basics: Are you doing top down or bottom up budgeting? Both have pros and cons and each has its time and place in an organization. Your Capex solution should support and improve either.
Bottom up – the project level approach
Capex is a project-driven activity and ideally should be budgeted project by project. The bottom up approach instills more rigor around strategic selection and ROI potential, and promotes innovation (after all, the best ideas often come from the “front lines” of your business). So it pays to ask: is the architecture of the Capex solution you’re considering truly project centric?
Yes, the thought of budgeting for every project can seem daunting if you’ve been laboring with spreadsheets. But a truly project-oriented tool eliminates that concern. It allows every user to input their candidate projects in a standard format with detailed financial information … consolidates all projects into a total budget proposal for leadership to review …, and does all this in one location without the constant back and forth of various spreadsheets. A purpose-built tool eliminates much of the “friction” that inhibits companies from implementing bottom up budgeting.
Collecting project-level data in a standard format in a single “repository” is essential but there are other things you need to be sure you’d be getting. For instance, be certain you’ll have the ability to “rack and stack” projects within portfolios. This will allow you to perform “what if” analyses so you can immediately grade and gauge the impact of choosing one project over another, and prioritize them based on good governance. For example: should we focus on expansion projects or on cost reduction projects? What is the cost and ROI impact of individual projects on the budget?
Moreover, be certain you can create multiple portfolios based on the criteria you choose, such as maximizing ROI, focusing on cost control, or growing capacity. If the Capex solution you’re evaluating does not support multiple portfolios then your team will simply not be as effective in making decisions as they could be. This is particularly essential for larger, distributed enterprises.
What about the future? Many projects are about keeping daily operations running: replacing a leaking warehouse roof, upgrading a 5 axis CNC mill, adding safety railing to the loading dock, etc.. But what happens when leadership embarks on a large, multi-phased, multi-year project? A robust Capex solution provides the additional capabilities necessary to manage complexity and long time horizons, including risk assessment and stage gates.
The top down approach
Top down budgeting, in which leadership sets a target for each business unit, is more of a “status quo” approach used when organizations lack the ability to collect budget data in a timely manner. Aside from being problematic (some say their budgets are obsolete before the “ink dries” on the paper it’s printed on), it can stifle innovation and buy-in from field operators.
So why would anyone still use the top down approach? Well, “a budget” is better than “no budget” and this approach *is* fast and at least provides some guidance. If you don’t have historical data or a firm detail plan for the next twelve months’ spend, then top down may be your only option. For that reason, it still should be supported by your Capex solution.
Be sure your Capex solution will be the sole collection and review tool for your budget even if you are collecting just one number from each business unit. You should not accept a spreadsheet upload without any support or commentary. You should have all budget items submitted via your Capex solution, viewable by all, and reviewed and approved by leadership using a consistent, dynamic and transparent rules-based methodology.
The real world
OK, enough theory and “best practice” talk. In the real world many companies take a “blended” approach. Be sure your Capex solution is well-suited for this.
This means that you should have the ability to submit the majority of your capital budget via the bottom up approach for mature, stable business units — which often leads to budget submitters having greater “buy-in” and ownership of their numbers. Be sure you can set up pools for “have to” projects. Pools are like a mini top down process; you know you have a given spend rate for maintenance so just budget at a high level. Safety and regulatory can also be budgeted via pools; you may not know each and every project that will be required but you know some spending will take place each and every year.
Also, new business units (or very small ones) may be assigned a set budget via the top down method. These organizations which do not have any history may simply not be in a position to create a detailed budget. In this case simply make an educated guess and incorporate updates via the forecasting process.
In the real world you need to balance the method used to capture useful data vs. the cost of that method. At the end of the day, your goal is to have a Capex process that is easy to administer and engage, which captures the required level of detail, including ROI justification, and which ultimately lead to better decisions, faster..
Budgeting in a full-lifecycle Capex solution that affords you the options you need will pay dividends in numerous ways: you’ll have more comprehensive data to work with; you’ll have greater confidence in the numbers you report; and, your annual process will be far more efficient. Perhaps most importantly, you’ll make smarter capital allocation choices that can drive growth, with lower risk.
Which is something everyone in finance would certainly also agree is a good thing.
(Want to read more about zero-based budgeting? Click here.)
Let’s get right to the point: you wouldn’t want to go into a battle blindfolded … and if making better capital allocation decisions is a priority at your company, you can’t count on an Enterprise Performance Management (EPM) system to enable you to do so.
That’s not to say that EPM software doesn’t have a place in your “finance stack” — of course it does … for operational budgeting and reporting.
But to optimize your capital investment … to make better, growth-driving decisions, you need to have on-demand access to the data that matters, rigor and flexibility in your approval processes, the analytical tools specific to capital allocation, and a holistic, portfolio view. It requires a “bottoms-up,” project-focused approach that a solution such as Finario provides … a solution that you can think of as an “EPM specifically for Capex.”
Getting down to specifics, an EPM, with its focus on departmental budgeting, treats capital projects as merely a line item. Total project cost, or total cost by month and associated depreciation. That’s it. Very “two-dimensional.” And while, yes, there is some simple workflow, it’s rarely enough for the typical complexity of a Capex approval process in a large enterprise.
Finario, on the other hand, is built around projects (called “investments” within the application to reflect a proper mindset for capital allocation). A large investment can contain dozens of costs, each with their own month-by-month cash flow projections along with a written rationale, ROI model, file storage and other capabilities enabling analysis and management of the project from idea inception, through budgeting, approval, forecasting and post-completion review. Risk models are built in, and users are able to visually rank projects based on their merits and immediately see the impact of those decisions on the budget. The template is flexible to allow as much information as necessary on large or strategic investments, or the bare minimum for small routine expenditures. And each investment’s cost detail is automatically consolidated into a multitude of budgeting and forecasting reports by entity and fiscal year – giving FP&A professionals exactly the information they need.
Finario also tracks each investment’s progress as a project against its budgeted and approved project goals, which may span multiple fiscal periods. This data is automatically rolled up into a bevy of reports and tools that give operations and procurement executives the information they need to manage projects intelligently, get an early warning of pending cost overruns, and optimize the overall project portfolio.
So, as you can see, while an EPM and Finario both offer budgeting and forecasting functionality, the focus and depth of information is very different. Which is why any business with meaningful Capex will need an “EPM for Capex” in addition to a traditional EPM. Fortunately, this will not add “yet another piece” of software to a stack, as it can replace both your homegrown Capex approval system as well as scores of spreadsheets, thus streamlining your overall IT infrastructure.
Most importantly, having all critical financial information related to every project in one system along with the workflow to approve expenditures and adjust budgets makes it much easier to make sound decisions in a timely way, with full confidence in the integrity of your data. More so, every approval decision that is made automatically updates your plan and forecast for the fiscal year. So if a project starts to go over budget, designated stakeholders can be automatically alerted so that they can make critical decisions, such as approval for additional spend or changes to the timetable. This is infinitely more efficient than gathering required data scattered across spreadsheets and other systems for each and every such change.
Another key difference is that the moment a capital budget is complete, a traditional EPM ceases to be of much use for Capex, while Finario has only begun to deliver value. It can help develop a cycle of continuous improvement where one year’s results flow seamlessly into the creation of the following year’s plan and decisions can be made quickly every month and every day in between.
Furthermore, when it comes to implementation, an EPM is a toolbox by design. It requires extensive and expensive customization for every customer. Finario, on the other hand, is already optimized for Capex. The configuration process is thus much faster and less risky.
All told, the benefits of having a clear-eyed, well-informed perch atop all capital allocation decisions are many. But the most important one, is perhaps this: having Finario at the center of your Capex management empowers you to go from an annual battle over a share of budget, to one of making solid arguments for individual projects based on their merits. The result: Misallocations avoided. Shareholder value optimized.
It is a concept that’s been around for more than 50 years, yet periodically re-emerges as a “trending topic.” This is one of those times.
I’m referring to zero-based budgeting (ZBB) — an approach Harvard Business Review characterized as being “elegantly logical.” At its core, ZBB dictates that every expense be justified individually for each new budget period based on its merits (“bottoms-up”), as opposed to using last year’s budget as a starting point and adjusting higher or lower (“top down”). Desired result: heightened accountability, transparency, and focus on ROI.
At a time when costs are being given extra scrutiny, and the imperative for strategic investment is more intense, the case for implementing ZBB would seem to be a smart choice. Yet, in an April survey of more than 300 global finance executives, only 26% said they planned to zero-base their budgets due to the pandemic, according to Gartner.
So, if ZBB is so “elegantly logical” and suitable to the situation at hand, then why aren’t more organizations deploying it?
A good place to start in answering that question is the realization that, as with most things, change can be hard. Moving to a ZBB framework may be more time-consuming and require additional resources. Add the “politics” and biases that often accompany budgeting shifts specific to Opex, and the status quo inevitably prevails.
This is why zeroing-in on the capital budgeting process can be an excellent starting place to apply ZBB. Capex, after all, is eminently focused, rigorous and accountable.
Why Start with Zero-Based Budgeting for Capex?
Consider the components of managing a Capex budget and the logic of making this the place to “kick the tires” on ZBB become more self-evident. By their very nature, capital projects are discrete and have a set of financials that can be easily compared to other projects. This makes assessing the impact of your move easier to gauge over time.
Capital budgets are also sensitive to changing dynamics in the marketplace, such as competitive pressures/opportunities, economic conditions, changes in the regulatory environment, etc. Having a more fluid means of assessing them can improve how your organization responds to opportunities, or contends with unforeseen challenges and threats. (Such as a pandemic.)
Then there’s the issue of creating a more discerning framework for determining which projects have merit, and which don’t. Ask operations, manufacturing, and IT for a list of their “needed” Capex projects and you will undoubtedly get many more than you can possibly budget in one year.
In theory, then, if management evaluates every project request on its merits, and either approves or rejects it given the needs and strategy of the business, and an anticipated return, resources will be better aligned and outcomes improved.
All that sounds great, you may say, but still doesn’t address the elephant in the room: how can you implement zero-based budgeting for Capex without it adding undo time and complexity to the process? That’s where Finario, an enterprise capital planning solution purpose-built for Capex, comes in.
The Advantages of ZBB with Finario
Having consistent evaluation criteria is essential to making zero-based budgeting for Capex work. Not only does it ensure an “apples to apples” consideration of business impact, it vastly speeds the process. Finario captures all projects in a central location, within a standard format, and lets you apply an established financial/ROI model and what if analyses. As projects under consideration progress through your approval workflow, all project details and assumptions are there for evaluation.
Though projects are evaluated on their individual merits, there still needs to be context relative to the entire portfolio and available budget. Finario lets you sort and group projects by objective (cost reduction, growth, etc), location, etc. so it’s clear how the budget is being allocated. Moreover, project proposals can be compared to completed projects for proper perspective.
By grouping projects into portfolios you can compare the impacts of different budget strategies. For example, create a budget that is mostly focused on cost reduction and another that balances cost reduction with some growth projects and still another that is mostly growth oriented. With Finario, you create these portfolios by just clicking the projects you want to include and can quickly see how those choices impact the overall profitability index and ROI of the overall budget. It’s a bottoms-up/ZBB process in it’s most intuitive and immediately impactful way.
Lastly, zero-based budgeting for Capex relies on coordination and communication. ZBB fosters better communication because all information (budget proposal, financial models, supporting materials) is dynamically updated and available in a central location. Everyone can see questions and responses without hunting through email. No more version control issues and no more emailing “the master spreadsheet” around the organization.
Now’s the Time
Zero based budgeting captures the imagination of finance leaders for good reason. It is a 180-degree swing from the usual top-down approach which, given the current economic realities and uncertainties, isn’t up to the task of ensuring that available capital is being allocated strategically, effectively, and opportunistically.
To go from theory to practice, however, can be daunting if approached from an “all or nothing” point of view. Which is why applying it to Capex makes so much sense, particularly if you have the right systems and tools in place. Capital allocation is critical to business sustenance and success, and warrants the type of evaluation that ZBB instills.
Yes, ZBB is “trending” yet again. But there may be no better time to go from contemplation to action than the present.
AZR strengthens capital expenditure budget control
With seven facilities strategically located throughout the U.S. and Canada, American Zinc Recycling (AZR) operates a diversified portfolio of businesses focused on zinc production and nickel processing – both from recycled materials. As the largest producer of zinc in the U.S., the company relies heavily on effective capital expenditure budget control to maintain its competitive advantage in the market.
Before Finario, AZR relied on an outdated paper-based system to manage its capital expenditure budget, which led the organization to get bogged down throughout the decision making process and obscured project status and overall spend.
“Ultimately, it was difficult to find out who was holding the approval process up and we didn’t have a clear sense of where we stood against budget when new projects were proposed,” said AZR’s Management Information Systems (MIS) Director, Mark Drobka…
Why your capital budget is probably being underspent
Your organization has just entered Q4 and the COO is concerned that it may, again, be under-spending its available capital budget based on the final Q3 numbers at hand. As a result, there’s fear that as a company, you may be missing out on capital investment opportunities that could potentially drive long-term growth and profitability for stockholders.
It’s a tale as old as time. You’ve held back on committing on what appear to be attractive investments because you’re not sure how they really compare with other projects tentatively placed in the budget or opportunities that may come along later in the year. Then, since it’s difficult to know where you really stand against budget across all the projects being invested in across the organization (and thus how much money is really available), you’ve held back to make sure you are not over your capital plan.
Now you face two options – neither of them pleasant. You can either race to spend as much as possible before the end of the fiscal year (and therefore overpay for the assets acquired), or underspend the budget and potentially dampen your company’s future prospects.
This is a common occurrence among companies of all sizes. Without visibility into what projects are being undertaken or even considered across business units, there’s no way to prioritize, approve and report on their performance.
To avoid these capital budget pitfalls, it’s imperative to ensure that all investments in the organization’s pipeline can be managed and analyzed alongside one another within a single system of record.
For further related reading, download our executive briefing, Exploring the Benefits of a Streamlined Capex Planning and Budgeting Process.
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- Applying consistent ROI metrics to projects
- Streamlining your approval workflow
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- Improving cash flow forecasting
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