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What is the process for redoing the income statement when one or more key assumption in the underlying budget goes bad (e.g., price of gas)?

alan dybvig's Profile

It is widely proclaimed in the literature that the typical budget is obsolete soon into the new year. This obsoletes the associated income statement, also. How, without redoing the tedious budget process, is the income statement updated?

Answers

Topic Expert
Wayne Spivak
Title: President & CFO
Company: SBAConsulting.com
LinkedIn Profile
(President & CFO, SBAConsulting.com) |

The income statement isn't obsolete, the comparison of actual to budget shows widely skewed variances.

The only way to "fix" it is to do a re-forecast and change the numbers starting in the next period, ie if you decided that the budget was way off in February and you can redo the budget by end of month March, then start the new budget numbers in March.

Topic Expert
Alan Hart
Title: Consultant
Company: Pacific Shine Group
(Consultant, Pacific Shine Group) |

As Wayne Spivak indicates in his answer, you should reforecast certain numbers in the budget if you believe the original budget numbers were incorrect, or the economic reality has changed, etc.

I highly recommend that your budgeting solution be set up to be driven by “drivers” where certain revenue and expense items can be driven by these specific driver values. For example, you mentioned price of gas as a factor affecting the budget. If price of gas is set up as a driver, all revenue and expense items that depend on this cost can be automatically updated if you revise this driver value over the remainder of the budget period.

Additionally, the budgeting software should be able to automatically generate all major financial statements and other user defined reports. In addition to to a forecasted Income Statement for each budget period (e.g., month), the system should also provide an automatically generated Balance Sheet and a Statement of Cash Flows for each budget period.

With the reforecasting of any item in your budget, all these forecasted financial statements and other reports you set up will automatically be updated, without you having to recompile reports, revise formulas and functions, etc. This will also encourage you to look at the actual results against the proposed budget more often and easily make the necessary adjustments along the way.

alan dybvig
Title: Managing Partner
Company: Dybvig Consulting
(Managing Partner, Dybvig Consulting) |

I completely agree with your driver recommendation. Question is whether one "drives" the budget or the income statement. Though you may not agree with the author's conclusions, I found an article which recommends the income statement statement persuasive. The article was published in 2011 and was written by Ventana’s Rob Kugel. It is titled “A practical look at Driver Based Planning.” It distinguishes, importantly I think, between planning "things" and planning money. For the article, with bold added, see

http://demanddrivenplanning.com/roi/wp-content/uploads/2016/01/A-Practical-Look-at-Driver_Based-Planning.docx

Quoting from the article: “While this might work reasonably well in setting a company budget, it’s difficult and time-consuming to update and manage changes in plans in a coordinated fashion.”

Continuing, he proposes that driver-based planning models are one such “coordinated fashion” mechanism. To do so, they must: 1) “have built-in volume-times-price formulas” and 2) that there are “persistent volume and price connections between plans of the various groups within a company.“ (NOTE: Elsewhere, Rob describes driver-based modeling formulas as units x rate = cost (URC) and this is the one I will use. This URC formulation, obviously, expresses cost as the dependent variable of units.)

To solve the income statement update problem completely though, I think three modifications need to made to his proposed driver-based formulation:
1. The model needs to be one totally interconnected model, not the sum of “plans of different groups.” This model would use the URC formulation for the COGS and G&A portions of the income statement. This is a common modeling practice today; e.g., supply chain network design.
2. However, a different formula needs to be used for the S of SG&A. This is because cost, in this case, is the independent variable and units is the dependent variable. Thus, the formula is cost x rate = units (CRU). This, too, is a common modeling practice today. For a short description, see Wikipedia’s article on marketing-mix modeling. https://en.wikipedia.org/wiki/Marketing_mix_modeling
3. Fixed costs need to be included.

Further, the need for driver-based planning models continues to be referenced in the trade press... along with the need for rolling forecasts, predictive modeling and more integrated planning linking finance more closely to operations and sales/marketing.
Very recent examples, fyi, include the following webinars:
1. APQC’s on 10/28/15 titled “Finance as a Driver of Operational Excellence through Effective Complexity Management”
2. CFO’s on 12/7/15 titled “The CFO Playbook on Budgeting: How to Keep Budgets Effective
3. CFO’s on 12/10/15 titled “The CFO Playbook on Performance Management: Realizing ROI with Corporate Performance Management (CPM) Improvements”
4. “Proformative’s recent presentation titled “Performance Management and the Agile CFO”

Finally, I am working with two the Proformative learning platform subject matter experts, one for budgeting and one for income statements, to determine whether there is a way, programmatically, to update both the budget and the income statement when changes occur; e.g., next iteration of a rolling forecast.

It will most likely work if the firm has a activity-based costing data available to create the necessary URC formulas; it is not so clear if other methods are used. See the following for a proposed process flow.
http://demanddrivenplanning.com/roi/wp-content/uploads/2016/01/Budget-and-IS-process-flow.docx

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