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Financial Forecasting, and what the hell is FP&A?

In this article we will review the main tasks that FP&A teams do at large corporations.
The acronym FP&A stands for Financial Planning and Analysis. In Europe sometimes it is called the “Economics” team. The task of the FP&A team is, as it sounds, to create the financial plan and analyze it. As part of this, they are tasked with creating the future forecasts, that provide their best guess regarding the future financial state of the company. These are called the financial projections. They can be created using an algorithm (e.g. machine learning algorithms) or by hand. In many cases, the end result is a combination of human manual work and machine learning algorithms.

Types of Forecasts

There are several types of forecasts for a company: there is the financial forecast (budget, expenses), there is a forecast for sales, and for demand (for manufacturers/importers, this is also called the orders forecast).

How forecasts are made

Forecasts can be prepared using a forecasting tool (forecasting software), or even in Excel. Sales or demand forecasts are created by the related department in the organization, e.g. by sales planners or demand planners. The FP&A team deals mostly with financial forecasts – e.g. revenue and expenses forecasts. Their task is to ensure that the forecast is as accurate as possible. Forecasting is a highly subjective job. The forecasts need to be constantly updated, as new information arises. By updating it constantly, it allows the company to better prepare for the future, e.g. to have a better cash flow projection.

In order to obtain the best forecast, a deep analysis is needed. A sophisticated machine learning algorithm is often used to forecast. Sometimes, due to inherent business complexity that cannot be captured by the forecast input, the forecast needs to be adjusted, taking into account the major business changes that may occur.

The global financial crisis of 2008 was one example of how many firms got their forecast massively wrong and had to change course, and even, for some, shut down the company due to inadequate financial results that were very different than what they predicted in their forecasts.

So, what exactly is FP&A?

And also, why is FP&A called Financial Planning and Analysis?

Actually, there is no hard-and-fast definition, or acronym. One definition for FP&A is

“the management of financial projections as a basis for planning the future”.

Another one is as follows:

“assisting the management in exercising sound financial judgment”.

This may be a little harsh, as many other groups within the company do the same job. For instance – human resources, legal, marketing and so on, need to have a good idea of what will happen in the future.

FP&A is often associated with the financial statements for companies. Any public company (and most private ones as well) spends a lot of time in the preparation and presentation of the financial results.

Important lessons learned:

There is no such thing as as one FP&A or financial planning process. Every company has its own. There are several steps in the financial planning process – sometimes called the “financial close”. This is because there are several steps after which the financial report is “closed” – no more modifications are allowed.

Types of financial activities

There are two types of financial activities –

  • Financial forecasting – predicting what will happen in the future
  • Strategic planning – deciding on what to do to mitigate and improve the future outcome

FP&A prepares forecasts for the company and compares them with the company’s plan, to be sure that the forecasts are consistent with the company’s overall plan. FP&A teams can also highlight where the forecast may be accurate, but can still be improved – in terms of business performance. It is not important just to have accurate forecasts, it is just as equally important, or even more – to improve business performance.

Steps to Create a Forecast

Creating a forecast involves several steps:

First, you need to make the assumptions for the future. Next, you generate an analytical model, which you analyze, to understand the path that the company is taking, in the near future, and in the long term. This is usually done in Excel – by using a simple analytical model, it is possible to “play” with the numbers, and plug in different assumptions every time. The goal is to find an accurate forecast, but also guide the company in choosing the right path in going in that preferable direction.

The analytical model contains many types of variables, but one important variable in the model is the time horizon of the forecasts. This variable represents how far into the future you are able to project. The higher this variable is, the longer the forecast is. For many companies, there exist several types of forecasts – short term, long term, and so on. There are different types of decisions that need to be made, depending on the time horizon.

The company may take a few weeks to complete this whole process. It is a challenging task.

What should I expect in my career as an FP&A analyst?

A large number of individuals work as financial planners, across the globe. However, there is no standard path to career as a financial planner.

FP&A is a broad skill, and not easily assigned to one specific job, over another.

It is mostly about studying the overall financial situation of a company. However, you should consider several factors. What’s the company’s overall business plan? What are its financial goals? And, what’s the general financial outlook of the company (to ensure stability).
This concludes our article, we wish you all success in all your FP&A endeavors.

For more information, please see this FP&A Article from the Corporate Finance Institute.

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Financial Forecasting, and what the hell is FP&A?
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