“What can be measured, can be managed.” This statement is certainly accurate with respect to the real value and purpose of using KPIs, or key performance indicators, as essential tools for measuring, monitoring, and managing process performance.

KPIs serve as benchmarks for identifying opportunities for optimization and innovation. They are of great use in decision-making, and are good instruments for creating accountability by setting clear expectations for execution. These indicators are mostly used to measure and evaluate performance against specific objectives or goals. For example, it is common for companies to establish KPIs as quantitative measurements of performance—to assess how well the organization is meeting its yearly objectives.

Even so, it is important to note that KPIs are not only limited to quantitative applications, as they can also be used to communicate good stories. Diligently analyzing and interpreting these indicators, far beyond comparing them to a target, enables the discovery of what they are truly communicating. By learning how to interpret KPIs, past events can be better understood and used as valuable evidence to predict trends, propose impactful business actions, and effectively communicate them across the organization.

Additionally, integrating and effectively managing KPI indicators through financial statements results, provides organizations greater visibility and improved decision-making processes that support their financial health, and enhance their ability to sustain long-term growth and profitability. For example, integrating Sales and Operations Planning (S&OP) KPI metrics, such as forecast accuracy, inventory turns, customer service level, supply chain costs, and working capital ratios, among others, to the Income Statement and Balance Sheet, allows businesses to achieve greater operational efficiency and financial results, which by effect, lead to sustained competitiveness and increased market value.

LINKING KPIS TO THE INCOME STATEMENT

The income statement is an essential financial statement that provides insights into a company’s economic position, profitability, and efficiency in generating revenues and managing expenses.

Income statement figures can reflect actions taken by demand and supply planning to make a positive impact on revenue, generate cost savings across various areas of the business, increase profitability, and optimize costs—such as selling and marketing costs.

Linking S&OP KPIs to the income statement, facilitates a direct understanding of how operational performance impacts financial results, and establishes clear correlations between them, thus leading corporations to strengthen their ability to make informed decisions that drive profitability and sustainable development.

From a revenue perspective, accurate forecasting ensures that the right products are available to meet customer demand, hence preventing lost sales opportunities. Higher customer service levels also drive repeated business, further boosting revenue. As such, improvements in forecast accuracy and customer service levels contribute to positively impacting the top line.

From the Cost of Goods Sold (COGS) viewpoint, effective inventory management reduces carrying costs associated with excess inventory, and minimizes the risk of obsolescence—resulting in lower COGS. Moreover, effective supply chain management facilitates negotiating better prices with suppliers, reducing procurement costs, and optimizing resource utilization. Overall, these cost-saving strategies directly impact the bottom line of the income statement by reducing operating expenses and consequently improving profitability.

The combined effect of higher revenue and reduced costs leads to improved gross margins. Gross margin improvement is a key indicator of the company’s operational efficiency and profitability, benefiting the income statement by impacting the company’s bottom line, while enhancing profitability and shareholder value.

LINKAGE TO THE BALANCE SHEET

The balance sheet is another essential financial statement used by organizations to provide a clear picture of the company’s financial position at a specific point in time. It presents the company’s assets, liabilities, and shareholders’ equity. While balance sheet items are not typically considered KPIs themselves, certain financial ratios and metrics derived from the balance sheet can serve as metrics to assess the company’s financial health and performance.

A typical indicator measured on the balance sheet is the efficiency of working capital management. Efficient planning techniques directly impact working capital management by optimizing the weight between current assets and liabilities. For example, improving forecast accuracy and inventory management reduces the need for excess working capital tied up in inventory. This by result liberates cash that can be used for other operational needs or investments, and at the same time, improves liquidity and financial stability, ensuring that the organization can meet its short-term obligations and/or invest in other significant growth opportunities. Another efficient planning technique is tighter accounts receivable management resulting from improved customer service levels that by effect can reduce the Days Sales Outstanding (DSO), further improving working capital efficiency.

Other S&OP KPIs such as inventory turns and inventory levels can directly influence the balance sheet as well. Higher inventory turnover ratios imply efficient inventory management practices, that lead to lower inventory levels, reduced excess inventory, and minimized carrying costs. Further, optimizing inventory levels reduces the risk of inventory write-downs and obsolescence, which can impact the company’s financial health and asset valuation. These reductions also free up cash for additional investment, and could even lead to debt reduction. Improved financial performance resulting from effective planning practices can positively impact debt management, enhancing profitability and liquidity for better debt management, reducing interest expenses and financial risk.

In summary, a strong balance sheet with healthy ratios, such as higher profitability and better liquidity ratios resulting from improved working capital management, can enhance the company’s creditworthiness, access to capital, and reduce its reliance on debt financing.

REPORTING KPI RESULTS TO EXECUTIVE LEVEL TEAM

Executives are mostly interested in the company’s financial health and sustaining its long-term growth and profitability. As such, KPIs play a crucial role in driving financial performance and aligning operational activities and efforts with strategic goals and objectives, ensuring that everyone is working towards the same outcomes.
The linking and analysis of KPIs to the company’s financial results is not fully successful until information is effectively reported to the Executive Level Team (ELT), as actions and important decisions need to be made accordingly. Reporting KPIs to Executives in a frequent manner can serve as the basis for productive discussions and collaboration among Executives, as this encourages dialogue around strategic planning, performance trends, challenges and opportunities, and enables informed decision-making.

When communicating and reporting KPIs to the ELT, it is of great importance to determine clearly what each KPI measures and why it is important for the business. It is also crucial to consider setting clear communication and presentation goals where relevant and meaningful information is presented to ensure that Executives have a comprehensive understanding of the organization’s performance and strategic direction.

When presenting KPIs, it is best to present them in a visually concise, focused, appealing, and easy-to-understand format via charts, graphs, and dashboards to illustrate trends, comparisons, and key insights. Including contextual information and analysis alongside may allow Executives to better interpret the data accurately. When deemed necessary, identify key findings and insights derived from the KPIs and highlight actionable steps or strategic decisions that need to be taken based on the results. Monitoring progress against KPIs over time is fundamental to track changes in performance, evaluate the effectiveness of strategies implemented, and determine the need to adjust KPIs or initiatives as necessary.

CONCLUSION

In conclusion, in today’s dynamic marketplace, it is vital for any organization in search of fostering a holistic approach to performance management, to be able to translate operational efficiencies into financial successes. As such, aligning a company’s operational KPIs with its financial statements can be of great help in support of this goal. The benefits of linking operational KPIs to the income statement and the balance sheet can be substantial, as they can drive organizations to better understand the financial implications of their performance metrics and make better-informed decisions to drive revenue growth, improve profitability, and achieve strategic objectives.

The standard S&OP process is a critical collaboration between sales (demand), production (supply) and leadership. However, when you look over the entire organization, key functions are frequently not represented such as Marketing, Finance, and others. While supply and demand are at its functional core, they exist within a greater context that is underpinned by Finance. Having a broader understanding of the financial environment in which S&OP decisions are made is key to an integrated and mature planning process.

The Financial Context

Demand planning and the S&OP process are tightly focused on inputs and outputs. What is increasing or decreasing demand? What factors are impacting supply? How is competition impacting pricing and margins? While these questions are important, sole focus on these fundamental components can obfuscate a larger context in which the business operates. Other business concerns exist that are dependent on the S&OP process including some that are ‘top-of-mind’ items for Finance professionals. The term “voice of the customer” is a common phrase used in business and, for the finance professional, these “voices” are specific to key stakeholders: the owner(s), the bank, and management.

The Owner(s)

The voice of the owner is shaped by three main factors: ownership composition, ownership priorities, and owner involvement.

Ownership Compositions: These vary from a single proprietor to limited partnerships to publicly traded companies with thousands of stockholders. Each of these ownership types present their own unique characteristics and challenges. Levels of access will vary from direct access and communication with a single proprietor to very limited access in the case of a corporate board of directors. Regardless of the challenges presented by limited access and communication, Finance has a responsibility to represent and convey those concerns and interests as they work alongside their functional partners within the company.

Owner Priorities: These take on different forms. Excluding non-financial considerations, owners are looking to increase the return on their investment in different ways. Some owners are very focused on short-term returns such as cash flow to see how quickly they can break even or a positive cashflow to finance their lifestyle or other investments. Other owners are focused on long-term growth of equity and/or overall business valuation. Their strategy is focused on building up a business as a long-term investment or for future acquisition. Finance’s role is to ensure the focus of the owner is reflected in both the presentation of information as well as strategic alignment.

Owner Involvement: This is an outcome of ownership composition. Under sole proprietorship, and even limited partnerships, direct involvement by the owners is extensive as they take an active role in the daily operations of the business. In larger businesses, less direct involvement at all levels of the business by the owner is common. The role of Finance here is to assist the owner in getting the information they need to make decisions in the format and frequency they prefer. The voice of the owner in cases of more direct involvement is very apparent, so Finance is in more of a supporting role.

The Bank

While the voice of the owner permeates all levels and areas of the business, the voice of the bank is isolated to Treasury and/or Finance functions. However, the implications of financing structures touch all parts of the business to some extent. Managing the requirements of financial terms and conditions requires coordination and communication with many functional areas who either contribute to, or are impacted by, these financing facilities. With that in mind, there are three main points that help to better understand the realities and requirements of financing.

Risk: While the business focuses on positive performance measures such as profitability, growth, cost control and equity, the bank uses these measures to determine the degrees of risk to the bank. The responsibility of Finance includes monitoring the cash and assets on which the collateral is based to ensure that the bank is satisfied relative to the financing.

Limited Understanding: Where many businesses only work with one bank, banks serve many clients. The result for the bank is that they have limited time and resources to dedicate to deeply understanding the business of each client. In consideration of this, Finance needs to clearly understand what information is important to them and mirror that focus through our analysis.

Covenants: Most financing facilities include requirements by the bank that the business maintain minimum performance standards. These focus on the business’s ability to maintain sufficient free cash flow and equity, manage the collateral, and other financial measures. These requirements may in some cases constrain the company’s ability to spend cash at certain times, limit the ability of the owner to access equity, and so on.  For businesses that are highly cash sensitive, coordination with production, purchasing and sales to monitor and manage cash flow is critical.

The Management

Finance works within and around management of the business but is uniquely positioned to interact with many, if not all, functional areas of the business. As such we have an opportunity serve as their eyes and ears. While individual managers have concerns specific to them, most in management have two main concerns: “What am I responsible for?” and “What is expected of me?”.

To support their concerns, we look out for situations or developments that will impact their departments that we can bring to their attention. We also look for ways that we can assist management in supporting what they are responsible for and/or expected of. Finally, Finance is presented with opportunities to assist management such as determining financial requirements for new ideas, projects, or initiatives.

These voices are always present and shape the lens through which Finance views the S&OP process. More than just another seat at the table, Finance has the ability and responsibility to inform, advise and contribute to the S&OP planning process beyond what is obvious to those native to S&OP.

How S&OP Can Support Finance

One of the best pieces of advice I received regarding my work in Finance is to “Know your business”.  This means getting beyond the financial statements, models, and ratios to really understand the nature of, and details within, the various functions of the business. To this end, the subject matter experts within S&OP are a tremendous resource to those of us in Finance.

Educating and informing your Finance person in the realities and nuances of your functional area can pay massive dividends. In so doing, you can become a true business partner to those in Finance and other functional areas as well.

How Finance Can Support S&OP

As mentioned before, Finance has the ability and responsibility to inform, advise and contribute to the S&OP planning process. We can accomplish this in several ways.

• Leveraging our exposure to a wide range of functional areas, we can help facilitate cross-departmental collaboration
• By bringing a fresh perspective we can ask probing questions to get to the root cause or key concept of a topic or situation
• We can provide feedback on the financial impact of their business decisions including things like cash flow, margin, and P&L impact as well as implications for financial covenants
• Incorporate financial constraints to long-term projections or forecasts.
• Help align to key financial metrics
• Advise on exploring new opportunities

Nearly every business decision has a financial component or impact and that’s where your local Finance person can add value and support.

Key Learnings From An Integrated Approach

About two years ago my company went through a restructuring of our teams where departments were reorganized, and a new group was created which we call the commercial team. The idea was to bring together the three legs of the stool on which the business operates: Supply, Sales, and Finance. With the managers of Operations, Sales, and Finance, our objective was to more closely align our work to improve controls, functional and market performance, and financial results through continuous improvements. We work and collaborate continuously together instead of just within recurring S&OP process cycles. Together, we do deep dives into each other’s functional areas to discuss issues and gain a better understanding. We are collectively responsible for all commercial operations and performance of the business and this shared responsibility fosters greater levels of teamwork than what you might normally expect from a siloed departmental structure. While not all businesses can replicate this commercial team approach in the same way we have, the principles foundational to this approach can be applied and the benefits can be realized.

The point is that the S&OP process should be just the start of a journey towards a deeper and more collaborative planning process that both digs deeper into each aspect of the business as well as expands beyond the traditional functional areas to incorporate and consider the broader implications. Of those, the financial considerations of the owner(s), the bank, and management are a great place to start.

To learn the fundamentals of business forecasting and demand planning, join us for IBF’s Chicago Demand Planning & Forecasting Boot Camp from March 15-17, 2023. You’ll learn how to forecast demand and balance demand and supply from world-leading experts. Click here for more information. 

Companies have been working on their 2023 business plans and budgets since the beginning of fall 2022. During this time, numerous developments have occurred in the economy and financial markets. One of the biggest concerns is rising interest rates around the world and how long they may remain elevated.

For the U.S Federal Reserve, the interest rate is expected to rise to 5.25-5.5% in 2023 and maintain that level until inflation is under control. Other central banks are taking similar actions around the globe. A U.S recession is expected in 2023, but its length and depth are uncertain.

Terminal interest rates will probably be held beyond 2023 and into 2024 – and perhaps even into 2025. Given the degree of uncertainty and global market risk, companies face numerous scenarios for which they must be prepared.

How Interest Rates Affect a Business

A key question for planning professionals is “How will interest rates affect my customers, my business, and my business operations?” Interest rate levels and changes can have both direct and indirect effects on a business and its customers.

1. They can affect the interest expense for financing working capital, such as inventory.

2. They can affect the financing cost of capital goods and capital projects.

3. They can affect the interest expense of rolling over debt when maturity has been reached.

4. They can affect the company’s cost of capital through interest expense directly and through investor expectation for equity returns as interest rates rise or fall.

5. They can affect the ROI hurdle rates used in making capital investment decisions and in product development projects.

6. They can affect the currency exchange rates faced by the company when buying and selling goods as well as those faced by the company’s customers.

7. They can affect the overall capital structure of the company through the relative proportion of debt financing and equity financing.

8. They can affect the interest costs for customers purchasing the company’s products, especially inventory and “big ticket” items like cars, trucks, and other capital assets.

So, interest rates and their effects are important considerations in many business scenarios for demand planning and Financial Planning & Analysis (FP&A) purposes.

Re-Evaluate Your 2023 Financial & Operating Plans

Any “approved” 2023 business plans, demand plans, budgets, and financial plans should be re-evaluated, and stress-tested to reflect how interest rate changes will affect the business and its customers. They may already be out of date.

Any adjustments to operational and financial plans should be made before implementing the financial reporting processes for 2023 to ensure that business metrics are utilizing a realistic set of goals, benchmarks, and budgets throughout the company. These should be periodically reviewed during the 2023 financial year. 2023 will be a time of changing business and market dynamics.

Interest Rates & Requests for Investment

When making requests for investment in product development, capital investments or new software, for example, it is important to consider the effect of changing ROI hurdle rates as interest rates change. The foundation of these ROI hurdle rates is the company’s cost of capital – debt and equity. The increase in interest rates into 2023 will have an associated effect increasing the investment ROI hurdle rates for the company so the justification for investments will require greater financial benefits. (ROI hurdle rates are also adjusted to reflect the degree of financial risk in investment types and so are modulated up and down to reflect this consideration.)

When requesting resources during 2023, it is important to work with the FP&A function to ensure that the request can be structured to meet the level of performance necessary to make the investment financially successful for the company.

2023 is upon us. It is essential that we be analytical and adaptive if we are to choose the best path towards operational and financial success. Understanding the impacts of interest rates is an important part of this effort.

To make S&OP/ IBP a reality in your organization, join us in Las Vegas for IBF’s S&OP/IBP Boot Camp. Running from February 15-17, 2023, it gets planning professionals up to speed with planning fundamentals and best practices. Complete with the chance to earn the world’s only S&OP/IBP certificate and 1-day Supply Planning Workshop. 

At the end of last year, I made this podcast that predicted that 2022 was going to be the year of ‘anti-lean’ with inventory flooding the market and companies having to offer discounts to shift excess stock.  My theory was that when we combine excess inventory with higher costs, higher interest rates, and a flagging economy, we have the perfect storm and that cash will become King for any business.

Succeeding in this milieu requires building cash reserves and performing effective cash flow forecasting. And that starts by taking a Finance-focused approach to S&OP and inventory management. This intersection between Finance and Ops is always important – but now more than ever.

To help get a handle on bringing S&OP and Finance together to help weather this upcoming economic storm, I spoke to Dean Sorensen, editor of Integrated Business Planning at the International Institute of Forecasters and founder of consulting firm IBP Collaborative. He has worked for companies such as Accenture, KPMG and AT Kearney, advising on finance strategy, cost and performance management and IBP.

The following questions and answers are taken from my conversation with him.

What’s the major difference right now between FP&A and S&OP?

First of all, FP&A is a function within Finance. When making a comparison to S&OP, it’s more relevant to address these differences in terms of a rolling forecast vs S&OP.

First of all, S&OP and IBP focus on supply chain resources and costs.  In most companies this represents anywhere between 50-60% of manufacturing cost structures. FP&A on the other hand focuses on 100% of the cost structure of the business.

Secondly, the structures of these processes are different. FP&A focuses on charts of accounts, whereas S&OP focuses on manufacturing and supply chain activities.  In other words, FP&A is vertically-focused, whereas S&OP and IBP are horizontally-focused.

Third, S&OP has formal mechanisms for optimizing tradeoffs. The classic one being between service levels, supply costs and inventory levels. While an objective of FP&A is to optimize performance, there are no such tradeoff mechanisms to do so.

What’s the difference between a demand plan and financial forecast?

It really depends on who you talk to. Personally, I see absolutely no difference between S&OP and a rolling financial forecast; it’s exactly the same process albeit at different levels of aggregation. The leading indicator of both these processes is an accurate cash flow forecast.

For a good cash flow forecast you need to understand how resources are being consumed. If you don’t understand resource consumption you can’t possibly get cash right. That’s one of the reasons why 99.9% of global manufacturers really struggle with cash flow forecasting. It’s hard to do when you don’t have the right models and that’s something FP&A lacks.

An operationally savvy finance person would acknowledge that you can’t possibly get a good cash flow forecast without a manufacturing model. If you don’t have a lot of changes in volume and mix perhaps you can get away with it but the minute things start getting complicated, you’re stuck. You can’t really run an effective FP&A process without bills routings and a supply chain tool – it just doesn’t work.

If our goal is to understand 100% of the cost structure and get a top-down view of cash flow, which should be the goal of any business, we need to connect supply chain planning with FP&A.

Does S&OP capture the bigger picture of a business?

The other part of the cost structure which, in my view, is falling between the cracks of both FP&A and S&OP, are the overhead cost structures. FP&A tools are really simplistic and as somebody who’s done a lot of cost management and cost reduction projects, traditional costing models are just wrong. We’ve known that for 30 years.

S&OP tools on the other hand are very narrow and fail to consider 100% of the costs. The consequence of that for one particular company I worked with was that because they were planning in silos, they had between 500 million and a billion dollars of sub-optimized resource allocation. These things are still falling between the cracks of finance and ops. 

We’re not showing the big picture of what’s happening inside companies and the overall health of the organization.

Is there redundancy across S&OP & FP&A?

If you look at S&OP and FP&A processes there are so many redundant and non-value activities between the two. We need to step back and look at the process as a whole and see it differently. It’s not that the standard five-step S&OP process is out of date, rather I think it’s missing some steps.

If you step back and look at the process more holistically you’re going to eliminate a whole bunch of things – you’re not going to need as many FP&A people, you’re not going to need a separate S&OP process, you’re not going to separate decision support process.

There’s a whole bunch of good reasons why one would want to have an integrated process that’s designed to be integrated from the beginning instead of operating S&OP and FP&A side-by-side. 

What does that fully integrated process look like?

One of the biggest problems that companies still have is that we still haven’t fixed the functional silo problem. One of the things that’s missing is what I call productivity management where we look horizontally across the business. For example, in an order to cash process, you want people focused on the cost per order, not trying to meet a fixed budget number. 

You also want them focused on customer/segment specific targets. The target for one might be ten dollars per order, while it might be five dollars per order in another.  You might have read the book Beyond Budgeting [by Jeremy Hope and Robin Fraser]. It talks about the bad behavior caused by budgets where neither the rolling forecast nor S&OP have fixed the problem of people being focused on functionally based budgets.

If you want to get them away from that you’ve got to replace it with something so rather than people focusing people on fixed budgets I want to focus them on somebody who owns the order to cash process I want you to hit ten dollars an order or fifty dollars an order or whatever I think it is and those you know those targets may um vary by segment but that I want them focus on relative financial targets. That is an absolute must. 

Beyond redundancy, what are the issues you’re seeing with current planning processes?

One of the biggest problems that companies have is they can’t connect targets to outcomes. Specifically, what do we want to achieve and how much is it going to cost?

Companies can’t manage the trade-offs between production costs, inventory levels, and customer service. From a finance perspective those trade-offs are between cost per order, order fulfillment days, and receivables.

If you take a walk around your company and ask who owns that trade-off you’ll find nobody owns it. The reality is that if you can’t manage those trade-offs, you don’t have a mechanism for optimizing cash flow.

How can demand planning ensure cash is King going forward?

Product mix is a good place to start. If we want to improve cash flow you may choose to offer products with a lower profit margin but will produce higher cash flow, as opposed launching a new product which is going to destroy cash flow. You can tilt decision making like this towards protecting cash.

I know a lot of S&OP processes miss the cash flow forecasting element, focusing instead on cost and service. And they look at inventory as just a target, not as a variable. Cash flow forecasting is missing in a lot of S&OP and FP&A processes right now and having that full visibility onto what cash outlook is important.

If you’re a 10- or 20-billion-dollar company, there’s no way that you’re going to do a cash flow forecast without a supply chain model. I see zero difference between a supply chain model and a cash flow model – it’s the same. If you have changes in volume, mix and price, you can’t possibly maintain that model in an FP&A tool.

Anybody who thinks they’re going to buy an FP&A tool and do cash flow forecasting is fooling themselves.

What you really want is to understand cash flow by business segment and understand resource consumption and cash flow by business segment. The only way that you can do that is by a forward-looking activity based costing model, i.e., a supply chain model.

This is the foundation for highly effective cash flow forecasting because If you can track changes in upstream activity which flow down to a downstream activity, you can relatively easily quantify how that impacts costs and cash flow.

Are planning tools up to the job of effective cash flow forecasting?

Most tools are not even remotely close to having the required level of sophistication. People in the FP&A software space are talking a lot about predictive analytics but the one thing you won’t see them talking a lot about is prescriptive analytics like the supply chain tools use.

The reality is that every finance guy is really going to want a prescriptive analytics tool because if I’m a treasurer I want to know how any given scenario is going to affect my cash flow, my working capital, my foreign currency exposure, my debt exposure, and whether I’m going to run into any debt covenant issues. This intersection between finance and ops is probably one of the least understood areas of business. 

Hopefully companies will start heeding some of these warnings and there’s a big incentive to do so. What we’re talking about is optimizing the cost of complexity and that represents anywhere between kind of three to five percent of sales.

Join us in Orlando for IBF’s Business Planning, Forecasting & S&OP/IBP Conference from October 18-21. With 2 maturity level streams, you’ll find the specific knowledge you need to implement or improve S&OP/IBP and level up your planning skill set. With networking and socializing in a wonderful Florida setting, it’s the biggest and best event of it’s kind. Register now.

2022 is beginning with substantial uncertainty and risk for businesses of all types. Much of this comes from the financial markets, and part of it relates to operating for 2 years in the pandemic. The list is long, but the main risks for demand planning and supply chain management are rising interest rates, shifting currency exchange rates, and price and cost inflation.

The interest rate risk is heightened by the planned normalization policies of central banks, including the Federal Reserve Bank of the U.S. Interest rates have been kept exceptionally low by central banks around the world, going back to the Financial Crisis more than 12 years ago. Rising inflation is forcing central banks to unwind their positions after years of accumulation and to increase their lending rates to banks.

Interest Rate Hikes Mean Changes In Demand

These will affect the cost of borrowing for businesses and consumers alike, in turn affecting the cost of inventory as well as the demand for products by businesses and consumers. For consumers who are acquiring products using debt (borrowing and leasing), the ramifications of higher interest rates can have magnified effects. Interest rates also impact currency exchange rates, adding more risk for global supply chains.

Scenario Planning To Mitigate Financial Risk

Now is the time for Demand Planners and Supply Chain Planners working within FP&A to begin developing risk scenarios for their companies, and to develop strategies to mitigate the financial effects for each. Given the number of risk elements for 2022, and the diversity of their effects by company and industry, scenario testing and planning is especially important. Contingency plans are essential in responding to changing conditions that will alter your product demand and business operations.

How Will Your Customers Respond To Interest Rate Hikes?

Consider how customers and consumers are likely to respond to interest rate changes and inflation in their budgets. For companies in your supply chain, how might they attempt to protect their margins with pricing that affects your costs of operation and your inventories? Consider how you can protect margins with price changes, and how that may affect demand for your products. Given the global nature of our businesses and the effects of currency exchange rates, how might company costs be affected by the coming changes in interest rates?

So, the scenario development and testing, and the development of contingency plans should be systematically undertaken. These should look at the effects on product demand, the effects on operational costs, the effects on inventory costs and financing, and how any ‘margin protection’ actions will impact demand.

How Will Your Responses To Risk Impact Your Trading Partners?

These issues you are facing are shared across all companies in the industry, and across all companies in your supply chain. The responses of each can be additive or multiplicative so Demand Planners need to create scenarios that fully incorporate the risk factors and understand the impacts of any resulting actions on our trade partners, as well as the effects of any actions taken by our suppliers and customers and consumers. Such scenario planning requires cross-functional participation to capture the many possible outcomes and risk factors. FP&A is essential to dollarizing each scenario and each course of action.

FP&A Must Dollarize Each Scenario & Response

Set-up a working group on a cross-functional basis with FP&A taking the lead in putting a dollar value on each scenario and response. This is not an operations forecasting process, but a scenario and contingency planning process. It is important for all members of the working group to realize this. Identifying the interacting elements and their effects on one another is essential. The process and the considerations are dynamic in nature, and will require iterations to test and evaluate the resulting scenarios.

Review these as a group on a regular basis to ensure prompt implementation of contingency plans and action. It is important to be prepared and it is essential to respond to the changing conditions on the ground in a proper and prompt manner.

Join us for IBF’s Demand Planning & Forecasting Boot Camp in Chicago from March 16-18, 2022. You’ll learn the fundamentals and best practices that turbocharge the value you add in your demand planning role. Trusted by Fortune 500 companies to onboard new hires, you’ll benefit from 2 days of expert instruction plus an optional supply chain planning workshop. Super Early Bird pricing now open – register now to secure your place at the lowest cost.

 It is important for both supply chain and financial professionals to consider the impact of mitigation and risk management efforts on company financial performance. Projected demand for upcoming periods must be planned for, and we look to balance supply and demand using demand forecasts and collaborative planning forums like S&OP or IBP.

In S&OP/IBP, business considerations and issues will be brought to the table that represent risks to the organization from operational and financial perspective. Strategies and mitigating actions are essential and should be chosen considering the expected financial consequences for the company.

The finance function is a key stakeholder in such forums as they supply information and financial analytics that can be used to ensure that all operations can be financed effectively and that decisions made contribute to a competitive ROI for the business. They are an essential part of the team in estimating and evaluating the alternative risk management alternatives available for risk mitigation strategy actions. Finance and supply chain functions have a shared responsibility for supporting the S&P/IBF processes.

Variation in demand as well as supply chain considerations can contribute to the need for safety stock, for example. It may require higher inventory and more points of distribution for the achievement of the desired level of customer service. It may require supply chain adjustments and mitigation that effect the business economics and business risks. Mitigations most often have financial effects – positive and negative – on the company. This kind of risk mitigation can be expensive.

Demand and sales forecasts are the platforms from which supply planning is launched. We are basing the supply chain structure, plans, and operations on these demand forecasts that then affect revenue and operating profit. Supply chains have a myriad individual supply links that interact with other links in the chain and with other supply chains. There are a host of supply chain risks to be hedged, mitigated, managed, and financially evaluated.

There are risks related to:

Disruptions: Supplier bankruptcies, natural disasters, and labor disputes.

Delays: Inflexible supply sources, capacity utilization, border crossings, customs.

Information Systems: System integration issues, networking problems.

Procurement: Exchange rates, single source materials, components, finished products for resale.

Inventory: Demand and supply volatility and uncertainty, excess and obsolete inventory, inventory holding costs.

Capacity:  Cost of capacity, cost of flexibility, capacity utilization rates, production flows and set-up, operational and financial condition of supply chain partners.

Lead Times and Related Volatility: Transportation, production, assembly, shipping components, supplies, raw materials, work in progress, finished products.

Demand Forecast Error: Excessive promotional activity, innately high volatility of demand, poor handling of data and information, poorly organized and poorly managed forecasting process, excessive forecast overrides and bias, lack of collaboration, key function participation

There are supply chain management mitigation approaches widely used for demand and supply related risks:

1. Increased capacity engagement through redundant suppliers
2. Increased oversight and responsiveness
3. Increased inventory and working capital
4. Increased company and supply flexibility
5. Aggregated demand to reduce uncertainty & forecast error

The mitigation approaches may result in increased product costs, operational costs, transportation costs, distribution costs, warehousing costs, and other supply chain management expense areas. Without the beneficial effects of higher revenue through volume and pricing, the mitigation approaches in isolation will probably have an adverse P&L effect.

They may reduce Net Operating Income, Net Income, and Cash Flow from Operations. So, it is important with support from the financial function to estimate financial effects and plan for actions that aid in improving other areas of the P&L – topline and/or expense – to achieve financial balance.

Impact On The Balance Sheet

Where the mitigations require investment in working capital and long-term capital assets, the balance sheet effects come to the fore. The investments will generally reduce cash, increase inventory, increase fixed assets, increase debt and the associated interest expense.

The Return on Assets and the Return on Equity are both impaired due to the reduced Net Income experienced by the company. The Return on Assets is further impaired by the combination of lower Net Income and higher Total Assets. So, again it is important to find other areas of the P&L and of the Balance Sheet with the support of the financial function where improvements can be made to balance the effects of the mitigation approaches on these key return metrics for the company.

Risk Mitigation Requires Collaboration

Throughout our demand planning and supply chain management efforts, we are dealing with volatility and other sources of risk to the business. The challenge is to be able to mitigate and hedge risks while producing a return on investment for the company.

This requires sharing of information and ideas, collaboration, and cooperation, as well as systematic analysis of costs and benefits expected from the mitigation actions that may be taken. It also requires both a short-term and a long-term perspective in our decision-making processes. The S&OP and the IBP processes are forums within which to do this.

We must consider the financial effects of our demand management and supply chain management activities on the operational and financial success of the company. We cannot do this in isolation. It is important to develop a relationship of collaboration with the finance function of the company to take part in our forecasting and planning processes, providing financial information, analytics, and financial counsel. This can help to realize an effective working relationship that balances the considerations of supply chain efficiency and operations, as well as financial ramifications and competitive financial performance for the company.

For further information on how Finance can benefit from collaboration with demand planning, click here.

Demand and supply planners are supporting decision-making efforts that have financial ramifications for the company. The company has many stakeholders who have a financial interest in the company with whom the management must communicate and interact. So, finance is an important skill and language for those who are leaders in the demand planning and supply planning efforts.

As demand planners and supply planners, we are committed to supporting the business decisions that are essential to making the company successful, making growth possible, and creating value for all of the company’s stakeholders. Through the demand planning and the Sales & Operations Planning processes, we facilitate the evaluation and selection of business alternatives that advance the company financially. Let’s review some of the financial metrics and issues that are of special interest to demand and supply planners.

The company’s financial statements are used to evaluate its financial condition. The financial statements are comprised of the profit and loss statement, the balance sheet, and the statement of cash flow. These elements make it possible to review sales resulting from sales and marketing efforts. They also contain assets and liabilities information, which reveals the resources used in the business process as well as the financial commitments made to support the business process.

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Profit and Loss

The profit and loss statement often gets the most attention, since it shows the revenue, the cost of goods sold, and the period costs and profit of the company. These results are shown for the current accounting period as well as for the fiscal year to date. The results are often compared to budget and to prior year results, allowing the user to see the financial performance directionally relative to prior performance. Key items for demand and supply planners reflected on these statements are revenue, cost of goods sold, gross profit (product profit margins), and selling and marketing costs. They are all affected by demand planning and supply side actions and reactions.

Revenue

Revenue corresponds to shipment volumes monetized by the net purchase price charged for the product. (The net purchase price reflects any discounts, promotional pricing, or other price adjustments affecting the stated price that would otherwise be charged for the product.) The cost of goods sold includes all costs required to produce and/or acquire the finished product. This includes both direct and indirect costs of production. Direct costs include all costs directly required to produce a product, such as raw material costs, modules, and direct labor costs of production. Indirect costs, often called manufacturing overhead, include all non-direct costs related to the production of the product. Importantly for the demand and supply planners, the cost of goods sold is also related to valuation of inventory being placed in storage as finished products.

Gross Profit

The gross profit, which measures the variable profit made from the sale of products during the period, is a key business metric. It represents the profit realized from the selling efforts, marketing programs, and production and distribution activities of the company. The gross profit is being affected by both the profit margin (%) and the sales volume. It is important that demand planners and supply planners know and understand the profit structure of their products.

EBITDA

A metric followed closely by investors, lenders, and the company’s senior management is a measure of operational cash flow before tax. The measure is earnings before interest, tax, depreciation, and amortization (EBITDA). This is an important building block used by businesses in estimating the value of the business, and the value creation potential of investments and business alternatives for the company.

The balance sheet shows the balances related to assets and liabilities for the company. The balance sheet contains financial values for both financial assets and physical assets. In the physical asset classification, work-in-process (WIP), raw materials, and finished goods inventory are particularly important to supply and demand planners. They represent a use of cash that ensures acceptable customer service and hedges against the uncertainty and volatility of demand with which the planner must deal. Using the cost of goods sold from the income statement, one can calculate the inventory turns being experienced by the company. One can also evaluate the impact of improved accuracy in forecasting, reduced volatility of demand, and other such considerations on the level of inventory required. Inventory is a use of cash, so anything that makes the inventory more efficient (for a given level of customer service) will improve the cash position of the company.

Financial Benefits Of The Planning Process

Any planning process is an investment by the company, one that reflects the expectation of operating and financial benefits. The company management is charged with re¬ presenting all of the company’s stakeholders, and very significant ones are the company’s shareholders, lenders, and employees. The financial performance of the company and its creation of value for its investor community is an essential element of a successful business. So, the expenditure of funds has to be considered in light of its contribution to the company’s goals and to the impact that it has on value creation. This is a responsibility of the management across the company, and the senior management and executives of the company in particular.

Planning process value can be created and enhanced in two ways. The first is by making the investment in process more efficient by producing more value with less investment. The second is to add incremental financial benefits as a result of the investment. The basic case for the Demand Planning and S&OP processes is that the company has more efficient operations, higher revenue, higher profits, better customer service, and a more efficient inventory as a result of an effective planning process. So, how do we measure the trade-off between the cost of initiating and running the processes vis-à-vis the benefits that are being realized?

We can estimate the cost of the processes on an ongoing basis, monetizing the compensation costs and other costs associated with the planning process. We can also estimate the quantitative and related financial benefits resulting from our planning efforts. Some of the potential benefits would be recurring cash flows and some benefits would be one-time cash benefits. And we can assess the related qualitative benefits that result from the processes. So we are balancing the quantitative and the qualitative results from the process and the company’s investment in it.

Let us consider the recurring benefits that may be resulting from the planning processes first. The possible recurring benefits could in¬clude higher fulfillment rates, higher customer satisfaction, greater revenue growth, lower product costs, lower transportation and storage costs, lower mark-downs and obsolescence, greater cross-functional efficiency, shorter product lead times, and overall higher profitability. And there are many more specific benefits that could be unique to your industry and to your company that would deserve your attention as well. Each of these can be analyzed to determine the cash impact of each, and can be included in a cash flow model to determine their value in comparison to the value of the costs of the process itself.

In addition to the recurring benefits of the process, there can be one-time cash benefits. The one-time benefits may be part of EBITDA, but most often they are cash benefits that are reflected in the values on the balance sheet of the company. In our case, the most probable benefits would be more efficient inventory—raw materials and finished goods—resulting in lower levels of inventory for any given level of customer service and sales volume.

The next step is to compare and evaluate the costs and the financial benefits of the process, along with the qualitative benefits expected. Using this information, we can bring together all of the costs and benefits into a holistic presentation and the desired course of action. It is important to boil this down to the essence of the sources of costs, the sources of benefits, and the net value that is created—both quantitative and qualitative.

Be holistic and creative in con¬sidering the costs and the benefits that can accrue to the demand planning and S&OP processes. Be honest and objective in your evaluation of the decision trade-offs. And be energetic in your recommendations for actions to management.

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Monetizing Process Improvement Investments

All of the evaluations undertaken for improvements are comparative analyses measuring incremental im¬ pacts on costs and benefits. This can be achieved, for example, by comparing:

• Revenue growth with gross profit growth;
• Profit margins with sales volumes;
• Order fill-rates with inventory levels or inventory turns;
• Inventory levels with customer service levels;
• Cost of markdowns and discounts with revenue and profit margins;
• Cost of sales, marketing, and pricing programs with changes in revenue; and
• Inventory levels and inventory turns with product lead times.

These are just a few examples of how this comparative evaluation can be structured. We are looking for relationships that help us take actions that positively affect company performance and value.

Demand Forecasts

The demand forecast and plan is a reflection of the historical demand patterns of customer behavior as well as the customer and market forces that are shaping future demand. It also reflects the volatility of demand and its effects on inventory and customer service performance. One can begin process improvement, for example, by ensuring that there is an ongoing activity for data cleansing to adjust the actual data for data shifts, structural changes, missing data, and data outliers. This will improve forecast accuracy. One could further enhance process results by ensuring the selection of the best forecasting model. This includes both availability of models appropriate to the demand patterns and selection of the best model. The result is concerned with how much it costs to cleanse data and find the best model in comparison to how much benefit will result from these efforts.

We can also assess how much the plan accuracy can be improved along with the financial effects of doing so. We can then progress from that to looking at the specific means of improving plan accuracy—making the action plans more effective and efficient in their design. The forecast itself may or may not meet the company goals. Most often, it will not. The responsibility of the planners is to build from the most accurate demand forecast available to the best plan that can be programmatically structured to achieve company goals, or get as close to them as possible. When the forecast and the plan are different from each other, which they usually are, the particular business actions and programs undertaken by the company to create the plan must be carefully and objectively evaluated. What are some of these actions and programs?

The business actions and pro¬ grams of which we are speaking relate primarily to actions that can change or shift demand, thereby affecting the revenue and associated profit experienced by the company. These typically encompass product pricing, product promotion, seasonal and other events, and discount programs, to name just a few. Often, these programs are estimated based upon judgment, intuition, and rules of thumb. The demand lift expected on these actions and programs can reflect the biases and the hopes of those who are responsible for them. We really need empirically reliable means of estimating the demand lift if we are to improve the accuracy of our estimates. The use of regression models to more accurately measure the effects of pricing and discounts, as well as the demand lift resulting from the marketing, promotional, and advertising programs can materially improve the estimates incorporated into the plans. This greater accuracy in estimating demand can be evaluated relative to the change in accuracy and the financial and qualitative benefits resulting from it. This allows us to measure the contribution of each to improvement in financial performance, and the related effects on company performance and value through the EBITDA, EBITDA multiple, expected growth, and working capital levels.

So, there is a cost of obtaining the greater accuracy in all of the above considerations. It may be personnel costs, research costs, contract costs, software acquisition and installation costs, and/or other such expenses. These can be compared to the benefits derived from the greater accuracy to determine the net benefit from the undertaking, which can then be translated into the impact on enterprise performance and market value. And it is this market valuation effect that is of greatest concern to shareholders and owners of the company.

Demand and Supply Planners’ Financial Dashboard

Given all of the various uses of financial metrics, what kinds of financial metrics and financial drivers should appear on a dashboard used by demand and supply planners? How should they be tracked? Essentially, any of the metrics are best used when shown as a trend through time, compared to goals, budgeted values, industry performance, and other benchmarks that enhance the usefulness of the tracking information. Some of the particular financial metrics that should be considered for inclusion follow:

• Revenue and revenue growth
• Shipment fulfillment rates and their trend
• Sales discounts—% of revenue and trends
• Product costs—their level, % of revenue, and trend
• Gross profit margin—level, % of revenue, and trend
• Selling Costs—level and % of revenue
• Sales program lift effects
• Marketing Costs—level and % of revenue
• Marketing program lift effects
• Finished goods inventory and inventory turns
• Raw material and work-in-process inventory — level and % of revenue

These metrics would provide a view into the macro financial performance and relationships within the business that are being affected by the efficiency and effectiveness of the forecasting and planning activities. There are many more that can be chosen, depending upon the financial dashboard being used by the company management participating in the processes and the executives who are making higher level business decisions. It is important to integrate the financial metrics being used by the company management into the dashboards being used by demand and supply planners in our companies. We can communicate more effectively the financial ramifications of our recommended actions and better present the financial implications of different scenarios, plans, and forecasts for the company performance. It also aids in our designing the most efficient, effective, and balanced forecasting and planning processes to advance the goals of the company.

So, look at the actions taken in the demand and supply planning activities, and relate these to the financial metrics that you choose to follow on your dashboard. A good indicator of what is important is to listen to the management speak about metrics that they are following in their respective areas. The more closely you can synchronize your dashboard with the concerns of the management in their fiduciary role, the more effective you can be in communicating with them and in providing information that is valuable to them in their management decisions. And after all, we are trying to provide better information for use in management decisions in an effort to benefit all of the company stakeholders.

Summary

Finance is an important tool and language in use by all businesses. Being aware of its use and applying it effectively can increase the value of the information that we provide to management as demand and supply planners. It can help us to forge a more productive relationship with the Finance & Accounting function, and better synchronization of our activities to create value for the company’s stakeholders. The demand forecasting demand planning, and Sales & Operations Planning processes are important to the efficiency and effectiveness of the company in meeting and satisfying customer de¬mand. Company performance and growth are dependent upon the success of these efforts. We are sources of value creation in our forecasting and planning efforts, and should ensure that we are as effective as possible in both the financial and non-financial dimensions that we affect.

Financial planning and analysis (FP&A) is the process of analyzing an organization’s financial strategy. To accomplish this, we need a prediction of a future P&L and cash flow or, in other words, a forecast. Many companies however do not create forecasts, instead operating from budgets, sales targets or some KPIs developed by the Finance department.

None of these are an adequate substitute for a robust forecast.

One of the oft-lamented drawbacks of the annual budget is that it is static in nature and it ignores changes in the marketplace throughout the year. Targets are set based on the various assumptions identified at the beginning of the year and sometimes, before the final budget is signed-off, many of these assumptions are already out-of-date and irrelevant. That reality was driven home in spectacular fashion by the last recession, which saw many carefully prepared budgets rendered meaningless.

Standard Financial Plans Are Disconnected From The Drivers Of The Business

The problem with these kind of budgets is that the forecasting process is disconnected from the specific drivers of the business. It fails to understand that the purpose of forecasting is to provide a picture of the strategic direction of the organization, identify potential risks and opportunities, and coordinate future activities. It is not a performance evaluation tool or a revalidation of the company’s commitments. When forecasting is used as annual performance evaluation yardstick, chances are that executives will purely focus on achieving the targets set at the beginning of the year.

But when the forecast is tied to sound predictive analytics, current sales, and changes in markets, executives have more timely and accurate information that allows them to make better decisions. What’s more, by tying the financial plans to the monthly forecasting cycle, executives can eliminate the annual mindset and become more aligned to business cycles. It is critical that instead of planning once a year on a top down number you are told to hit, forecasting is based on real business demands and the real business environment – and for that we need to update the plan more regularly.

The Power Of Rolling Financial Forecasts

To do this, many companies are abandoning the annual budget and moving towards a rolling forecast or continuous planning. This is a process in which key business drivers are forecasted on a continual basis. To do this, Finance must not try to recreate the annual budget process every month, nor should they shortcut it and just use averages.

Forecasting a P&L is about estimating revenues of sales, costs of goods sold, and SG&A costs (selling, general and administrative expenses) for the upcoming period. At first glance, a tempting and time-saving approach for the organization might look like a summarized P&L for the forecast period. Much better, however, is a more detailed P&L elaboration, reflecting fact-based past experience, the best available knowledge and the soundest assessment of the future environment and business development.

Finance Must Work With Demand Planning

For this reason, the forecast should not be the sole work of the Finance department, for it may not have all elements available to make its own assessment of how the market is developing. Instead, it should be the result of collaboration with the predictive analytics and demand planning functions. Working together they can get the complete picture more efficiently and effectively.

Finance must work with predictive analytics and demand planning for a truly robust forecast

This coordination ensures best practices in data gathering and analysis, modeling, managing assumptions, and, just as important, monitoring performance. Good forecasting and demand planning help us better understand the uncertainty of demand and adapt to changing conditions.

Furthermore, developing a monthly P&L and rolling forecast using the forecast created by the demand planning and forecasting function creates a one number attitude throughout the organization. In this scenario, the same forecast that drives Operations and Sales and Marketing is now driving gross margin, variable cost, and cash flow. While there may be allowances and other financial adjustments to the sales forecast, using the same baseline allows you to tie and understand the drivers and variables better.

What The Rolling Forecast Most Definitely Is Not…

Finally, the rolling forecast is not an annual budget done twelve times a year. If it takes you eight weeks to recreate a forecast every month, you may have a problem. Using the sales forecast generated by demand planning is not only a best practice but saves time and resources and allows finance to focus on financial drivers.

In this new business environment where we need more insights faster and be more agile, we need to leverage resources and processes that are responsive and understand customer demand. As today’s culture of ‘disruptive’ thinking begins to permeate every corner of business, approaches to processes such as budgeting and financial forecasting are also evolving. Being adaptable and collaborative is now the name of the game, and if a company’s finances can’t keep up with ever-changing scenarios, the outlook is grim.

Forward thinking companies have recognized that traditional financial forecasting is inefficient and are getting demand planning to help

Today companies have recognized that traditional financial forecasting is inefficient and have moved to demand planning function or specialized planning and forecasting roles to help. Advanced predictive analytics functions are being leveraged throughout all parts of organizations and for FP&A, it can be a source of strong competitive advantage. This is also the basis of a good rolling forecasting process which invokes consistency and participative cooperation across functions in organizations.

Attention Demand Planners, wouldn’t you AND your CFO both like to know how much profit your current forecast is leaving on his table? Turns out you can; all that’s required is getting a second opinion of your current forecast just like you would if you had an important medical condition. Or, another way to think about it might be as an analytic consultation of your forecast. 

How Does The Second Opinion Forecast Work?

First, a bit of background is in order. As is well understood, the most important element in developing next year’s plan is the forecast. This forecast is “translated” into next year’s profit by subtracting the income statements’ various costs from the forecast’s revenue; specifically, cost of goods sold and sales & marketing, general and administrative costs. These costs come from the budget. Thus, the forecast in concert with the budget determines for the CFO next year’s planned profit.

The Second Opinion Forecast has no dependence on next year’s budget.

The Second Opinion Forecast (SOF) is developed entirely differently; it has NO dependence on next year’s budget. This fact should  please your CFO given the current budget’s widely recognized limitations, including short life-span, how time-consuming it is, and how rapidly its assumptions are outdated.

Rather, SOF accomplishes this independence from the budget by building a model of the income statement, an Operational Income Statement (OIS).  This model integrates two analytic techniques in widespread use today.  The first is Supply Chain network design and the second is demand-sensing modeling (often referred to as marketing-mix modeling).

How To Create An SOF Model

There are three steps involved in creating an SOF model:

Step 1: Working closely with the CFO’s management accountants within FP&A, a model is built from last year’s income statement (i.e. profit and loss) in Supply Chain network design software. This model, the baseline, ensures the model has structural integrity, typically modeling last year’s results to within 1-2%. However, this model differs from network design efforts because its planning horizon is only a year and it includes SG&A costs.

Step 2: This model is then updated with next year’s planning data including:

• Replacing the sales/marketing costs in the baseline model with demand sensing functions which describe how the forecast volumes vary as a function of sales and marketing expenditures
• Reflecting any and all improvements planned for the Supply Chain in the coming year including changes in sourcing, process improvements, in/outsourcing decisions, new production lines, plant facilities, etc.

Step 3: This updated baseline model then selects the Sales & Marketing expenditures which create the most profitable forecast using the demand sensing functions. This demand-sensed forecast is the SOF forecast.

Second Opinion Forecasting allows the income statement to be updated much more quickly and accurately during the year.

Why Is The SOF Important?

The SOF allows the CFO to compliment the current financially-based enterprise planning efforts with the same planning foundation that the Supply Chain currently uses, i.e. Operations. As described below, the benefits the SOF provides for the enterprise in general and the Demand Planners in particular, are significant.

There are a variety of benefits including:

• Creation of a new maximally profitable demand-sensed forecast, the SOF
• The SOF model configures the best Supply Chain required to make and fulfil the SOF, respecting all the Supply Chain’s constraints including sustainability (e.g., energy consumption, carbon emissions
• It allows the income statement to be updated much more quickly and accurately during the year
• It improves the forecast process’s profit results going forward
• It maximizes the return on investment of  sales and marketing expenses
• It fulfils a long-held belief amongst Demand Planning experts that Demand Planning is held back by being purely a Supply Chain-focused function. There’s no real reason it should be limited to Supply Chain.

Almost three decades ago Sales and Operational Planning (S&OP) burst onto the Supply Chain scene as the latest innovation. When S&OP as a concept emerged in 1987, we didn’t even have the internet, much less the Internet of Things. Printouts at the time were from dot matrix printers, and we could not even conceive of 3D printing. It’s amazing we could even have S&OP meetings considering PowerPoint only came out 3 years later in 1990.

S&OP Process Improvement Is An Illusion For Most Companies

What we see now may be an illusion of progress masked by new terms, and executives believing what they want to believe. The more people speak about something, the more we perceive we know about it, and this phenomenon holds true in Supply Chain (it works great in politics as well). Everyone throws out the terms and buzzwords with few of us knowing much about it or if it does what it says.

The truth is settling in that the vast majority of companies, despite intense efforts, cannot demonstrate any measurable improvements in their company’s performance.

What we do know is that repeated research shows over two-thirds are failing to extract any  value from their S&OP process. Despite the mountain of research on how to develop a mature process and the millions of dollars  spent – the Gartner five step maturity roadmap reveals 68% of organizations are scored at 2.6 or lower – that means they are barely coping with balancing demand and supply. The truth is settling in that the vast majority of companies, despite intense efforts, cannot demonstrate any measurable improvements in their company’s performance.

Possibly the most incriminating report came from the Institute of Business Forecasting (IBF) Global survey (2014). In this study, Dr. Chaman Jain researched 664 North American companies,  471 (71%) of which said they had an established S&OP process. When looking at Days of Inventory, surprisingly there were not only no improvements, but the 471 companies with an S&OP process actually did worse (39 Days of Inventory for companies with S&OP compared to 37 Days of Inventory for all companies). When measuring back orders as a percent of sales and looking at service stock outs, S&OP presented no discernible effect.

If S&OP is having difficulty keeping up with business today, how can it keep pace with the business of tomorrow?

Understanding the Larger S&OP Problem

The bigger question is not whether S&OP is able to add value to Supply Chain today, but whether it will be able to keep up with what is coming. There is no doubt that everything else will continue to evolve around us, including business. All the challenges we face today will be amplified in the future, and we will surely have new people with newer skill sets, new technology and capabilities, and ideally new processes.

Cycles will get shorter, data will be bigger, and collaboration and value may take on a whole new meaning in the enterprises of the future. Although many companies are recognizing the need to become more responsive and flexible, most S&OP processes are not designed to cope well with ambiguity. The leaders in the future will be the ones that can more efficiently see, interpret, and act.  This is what executives will be looking for, a better way of gaining insights into their business that enable them to make better and faster decisions. If S&OP is having difficulty keeping up with business today, how can it keep pace with the business of tomorrow?

The limitations of the S&OP process and the changing business landscape necessitate a broader approach to the planning process. Planning can no longer remain within the realm of Supply Chain alone if it is to have a meaningful impact on the business. The S&OP function should be elevated into a central business planning & execution framework. This framework will help executives deliver a better way of making better decisions on a faster timeline.

Rethink People, Process and Technology

Rethink People: The core should be comprised of people with strong analytics capability and people with business savvy & influence. This creates synergies between the business team members to ask the right questions and analytics team members to find the right answers. Talent is scarce, so organizations should recruit from across the organization and nurture potential candidates.

Rethink Process: Organizations should establish a centralized fully integrated forecasting, business planning, and analytics function to support decision making and a repeatable process to create value, manage risk and coordinate enterprise wide decision making. Consider Business Efficiency Planning (BEP) as part of a continuum of a natural progression towards deeper integration across disparate business functions to facilitate deeper alignment and maximize business value. The path to BEP begins with well-established foundational S&OP processes along with other processes such as PLM & FP&A.

Rethink Technology: Organizations should invest in a technology landscape that includes core applications with embedded capability, open-source analytics engines and self-service tools to consolidate data and provide prescriptive and predictive analytics for all business functions. This may include: customer analytics, consumer insights and/or geospatial analytics in addition to traditional forecasting and supply planning capability.

The first step is simple and any company has at their disposal. Organizations can get quick wins by aligning discrete decision-making process and improving participation and alignment between FP&A and S&OP processes. Developing a strong forecasting team and core data & analytics function to serve each function’s needs and acquiring leadership buy-in to define a roadmap that integrates the foundational processes with the overall business strategy.  Finally build a roadmap to Business Efficiency Planning to align all functional areas to a unified set of assumptions and to enable and coordinate decision making.

[Ed: this article first appeared on the Arkieva.com Blog. You can find the original at this location.]