The 80-20 rule (based on the Pareto principle) has been applied in numerous ways to identify and solve many management issues. In the world of financial planning and analysis, this cause and effect methodology unearths an issue where 80% of resources and time are spent on creating the budget and forecast when in fact it should be the other way around; 80% of the time should be analyzing information and determining its impact on the organization. This post discusses how we can use lean practices in conjunction with a tool like Oracle Hyperion Planning to overcome this issue that plagues many organizations; we will use expense planning as an example:
Figure 1: Illustration of a lean expense planning budgeting cycle execution
Imagine a scenario in which we can identify expenses (typically operating expenses), where the budget for the following year can be pre-populated via Hyperion and approved without too much iteration. For example, if rent is expected to increase by 5% and social security taxes are expected to increase by 2% in the following year, the budget for these expenses can be easily pre-populated by setting up calculation scripts to copy the data over with the associated increase. As long as the budget approvers are able to see that the budget increase compared to the prior year’s actuals is close to 5% for rent and 2% for Social Security, they can approve the budget without too much iteration. Using this example, we will look at how to extend this to 80% of the budget.
Most organizations start expense planning by looking at prior year actuals. The goal to achieve is how your team can meaningfully pre-populate the following year’s budget and then spend your time wisely on the remaining activities as follows:
1. Classify prior year actuals by categorizing each expense into one of the following expense categories: run; one-time expenses; one-time grow; and recurring grow. Once tagged accurately, you will notice that the expenses that are tagged as run and recurring grow are typically 80% of your total expenses.
• Run expenses are the equivalent of “keeping the lights on” expenses that are recurring, e.g., rent, electricity, and full-time employees’ salaries.
• One-time expenses are just that – they are one-time in nature and will not recur in the future, e.g., roof replacement at an office location.
• One-time grow are unexpected expenses that apply only to that calendar year, e.g., costs related to hiring consultants on specific projects.
• Recurring grow are expenses that will recur into the future, e.g., maintenance costs on newly acquired hardware.
2. Best practice is to tag expenses in the above categories when businesses review actuals on a monthly basis. Alternatively, you can choose to do this as a one-time activity at the beginning of your budgeting cycle but this is not the recommended approach.
3. Forecast the months for which you do not have any actuals data. For example, if you have only 10 months of actuals data, you can run a calculation script that pre-populates data for the two missing months based on run-rate, last month’s actuals, or an approach that fits your organization’s expense patterns.
4. Once you have 12 months of actuals and/or forecasts, copy the run and recurring grows as the base for the next budgeting cycle (80% in the next step). Don’t copy over the expenses tagged as one-time in nature as they are not expected to recur into the future. Alternatively, you can copy the entire budget and delete the expense items tagged as one-time items.
5. Follow the 80/20 rule on Operating Expenses: 80% of Budgets and forecasts are typically running expenses (keeping the lights on) with adjustment for increases or decreases based on inflation, tax changes, etc. These 80% of budget/forecasts are usually operating expenses and can be setup automatically via calculation scripts in Hyperion. As long as senior management and budget approver sign off on the guidance on inflation percentage, tax increase percentage, etc., this 80% budget can be setup easily without manual input, reviewed by departments and budget owners, and approved by senior management as the increases or decreases will match their guidance.
6. Some specifics for operating expenses related to capital are as follows:
• On existing capital that is already live or currently depreciating, the depreciation schedule can be setup as a calculation and needs no manual user input.
• On existing capital that is on the books but not yet live, the depreciation schedule can be setup via a form or calculation script and needs no manual user input.
• On new capital that is not yet purchased or delivered but is expected to go live in the following year’s budgeting cycle, the depreciation schedule can be set up via a form and calculation and needs no manual user input.
By using a combination of this sound process and Hyperion’s capabilities, your organization’s time and resources can be spent better focusing on the remaining 20% of the expenses, which typically focus on the future growth of your organization (like new projects, capital expenses, etc.) and the time spent reviewing and analyzing these items is time and money better spent for you, your organization, and all your stakeholders, both internal and external.
Author: Sreekanth Kumar, Performance Architects