COVID-19 has severely challenged and exposed gaping weaknesses in financial planning and analysis (FP&A) for manufacturing. Forecasts and models based on traditional historical data failed in the face of a massive and unique disruption. Finance and accounting departments rapidly retreated and focused on forecasting cash to support business survival—critically important, but could more have been done? What lessons should we learn about how the FP&A function must improve for the future?
The most important lesson is the need for an integrated, very near real-time operational and financial model of the organization. This model needs to be causal and reflect the reality of resources and processes for the entire organization, not just production, and not just for financial reporting. COVID-19 affected every part of the organization. An important element of causal modeling is the nature or responsiveness of resource use (and the related cost flows) as fixed and proportional (or any other relationship). These definitions are contentious because they are often misunderstood and mis-applied; done correctly they provide deep insight into marginal costing as well as profitability, and facilitate cash flow analytics. Some would argue that COVID-19 made all costs proportional, but that is an incorrect characterization. COVID-19 made many costs avoidable (both fixed and proportional costs) that had never been considered avoidable before. The characteristics of fixed and proportional relate resource use and cost to output whether the objective of the work is regulatory compliance, making payments, or producing a product. Manufacturing has long used real-time operational systems for production, but finance is generally far from integrating financial information with operational systems in real time. The technologies and methodologies are available, but the finance and accounting profession have not embraced the importance of managerial costing knowledge for internal decision support.
A second important lesson is the need to create causal models for customer profitability that go far beyond product cost. Customer profitability is impacted by many non-manufacturing costs associated with acquiring and managing customers, such as marketing and selling costs, discounts, order size/frequency/complexity, change requests, frequency of ordering and shipping, customer profitability information, and others. It is difficult to decide how to prioritize customers without this information when you have limited production capability, as was often the case during COVID-19. In normal times, comprehensive customer profitability information can greatly improve an organization’s strategic focus and profitability.
A third area COVID-19 has exposed as a major risk area and profitability constraint is the supply chain. This has long been an area of focused cost reduction. However, COVID-19 is redefining supply chain optimization to put more emphasis on continuity, viability, availability, and location. Investors have been brutal in demanding ROI improvement—often by limiting investment—but when supply chains are considered, it may be time for some serious investment and even vertical integration.
The overarching lesson from COVID-19 is the need for continuous, causal, and agile operational and financial planning—including contingency planning for severe global events. Government agencies and the military continuously plan, exercise, or wargame for extraordinary contingencies—these involve the initial response, and the ability to maintain a sustained response. While manufacturing companies aren’t in the emergency response business, they must be economically resilient, which means planning to maintain an economically viable level of production and sales. Financial planning and analysis done with strong awareness of operational needs and a causal model of economic realities can be a competitive advantage for a company. Expanding the capabilities of FP&A beyond external financial reporting results by developing more robust models for internal decision support and operational systems integration is a top priority and a first critical step. The Institute of Management Accounting’s Profitability Analytics Framework and Conceptual Framework for Managerial Costing Statements on Management Accounting, a new Profitability Analytics Center of Excellence, and the Resource Consumption Accounting Institute offer information and guidance to improve FP&A’s operational and causal focus and modeling for internal decision support.