This is the fifth in a series of blogs on improving the corporate budgeting process. In the last blog I covered splitting up the budget into fixed and variable items. In this blog we look at developing driver-based relationships. With budget measures whose values are variable, it’s often possible to develop a ‘cause and effect’ link to help predict its value. For example, sales revenue is the product of marketing, lead generation, sales calls, customer references and signing contracts. Similarly, production costs are the product of buying raw materials, fabricating them into products, packing and shipping them to customers. The linkages can be modelled so that entering information such as workload or targets to be achieved, can then be used to generate the workload and hence the resources required. This is known as ‘driver-based’ planning. Drivers are found by taking a target measure (e.g. revenue or some other ‘outcome’) and establishing what directly impacts its value. For those items, we then establish what impacts them – and so on. Measures at the end of the chain are known as ‘drivers’. By entering data into a driver value allows the model to calculate the target measure.
Sophisticated driver models recognise constraints such as production volume and that at certain levels cost and revenue profiles may change e.g. the impact of discounts, late delivery penalties, or that more staff will be needed which will cause a step change in values. They also recognise that there is nearly always a time-lag between the driver and the result it supports.
Driver-based models are good for modelling the relationships between activities and can be used to quickly generate future outcomes, but without the time, effort and politics involved in setting these values. However, driver-based relationships do not take into account unpredictable external influences such as the weather and they can only model what has happened in the past, which may not be a reliable indicator of the future in a volatile market or where product life cycles are relatively short. As we will see in a later blog, this linkage between resources, workload and outcomes allow management to assess whether budgets (or forecasts) can be justified and whether the relationships reflect the reality of how business is generated.
- Identify which measures could be driven by others.
- Look at past results – is there a connection that could be used as a reliable indicator of value?