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Strategic Budgeting/Forecasting Questions: Representation of Strategic Initiatives in the Budget and Forecast

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The second entry in our 6 blog series about Strategic Budgeting/Forecasting Questions builds on an understanding of Question 1. Having identified the financial direction of each strategic initiative, decision-makers are better positioned to look at the budget and see how the initiatives are represented and, of course, ask “why” questions.

Question 2 – How are strategic initiatives represented in the budget and forecast?

Take, for example, a strategic initiative of being the lending machine. One of the first areas decision-makers would look to see how this initiative is represented in the budget is loan growth. Given the initiative, one would expect to see loans increasing compared to previous years. But, what if the loan growth in the budget was the same as previous years? Would that be reasonable? It depends, and what’s key in answering this question is understanding the “why.”

Example 1: Why is loan growth the same as the previous years? Answer 1: There are headwinds the credit union is facing when it comes to loan growth (more on this in the next blog in this series about Question 3 – What key forces could impact our forecast?). Without the lending machine initiative, loan growth would actually decrease in the following years. So the impact of the initiative is actually keeping the loan growth steady. This may be a reasonable answer.

Example 2: Why is loan growth the same as the previous years? Answer 2: The trending from the current year is carried forward into the budget. This is not a reasonable answer and is not representing the strategic initiative. In this case, the budget should be adjusted to reflect the initiative.

What can also be helpful is looking at the budgeting/forecasting trends with and without the impact of the initiatives. Start with a current path where the strategic initiative(s) are not incorporated and it is “business as usual.” Then run a path where the initiative(s) are included and compare the two.

Using the lending machine example, the chart below shows how loan growth and ROA would decline in the current path without implementing the initiative. With the initiative, loan growth stays steady in 2017 and rises in the years after, thus, increasing ROA and net worth. This comparison creates an opportunity to ask and discuss many “why” questions and see how the initiative is represented in the budget/forecast.

Again, the key is understanding the expected financial direction, looking for how that’s represented in the budgeting/forecasting, and then asking why. Even if the representation of the initiative in the budget is reasonable, it’s important to have strategic conversations on the “why” which will help create clarity among decision-makers.

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Strategic Budgeting/Forecasting Questions: Connect Strategic Initiatives with Financial Direction

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Strategic initiatives impact results – members may be better served and membership may grow, assets may grow, and earnings and net worth may increase. Some strategies may cause temporary or long-term reductions in membership, assets, earnings, or net worth. Budgets and forecasts should incorporate the anticipated impacts of strategic initiatives and establish common expectations for results. Connecting the dots to better understand the financial implications of strategic initiatives can lead to greater success.

In this and subsequent blogs, we will review 6 questions strategic boards can discuss during the budgeting and forecasting process to better connect the dots. These 6 questions are merely a starting point and will undoubtedly lead to more questions during the process, creating more thorough communication and a greater understanding of strategic plans.

Question 1 – What is the expected financial direction of each strategic initiative?

Begin with a simple, high-level assessment of strategic initiatives. Identify each strategic initiative with a short description. Then, consider what you believe will be the earnings impact next year and in the following years. For this exercise don’t focus on the numbers, just consider the direction of the impact. Draw a quick table or use a spreadsheet as follows:

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Consider that not all strategic initiatives will generate increases to earnings. The important point is to understand why. Some initiatives may hurt earnings in the short term to achieve longer-term improvements, while others might only reduce earnings. For example, a strategy might be to increase member giveback through reduced overdraft fees or installing additional ATMs for improved member access.

In this example, initiative #1 is to become the lending machine – perhaps to make the process more efficient and create capacity – or to generate more loans for the credit union. This initiative may include a project to implement new technology or acquire talent. In Year 1, the project is expected to incur costs that would reduce earnings, or the ROA. We indicate that in the chart with a downward arrow. By Year 2, however, we expect to see some additional loans or experience cost savings that would improve ROA. We show that with an upward arrow.

Continue to complete the chart.

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In Year 3 and beyond, the impact to ROA of the lending machine strategic initiative is expected to continuously increase.  We can use multiple arrows to show the additional impact expected.

For strategic initiative #2, to decrease account opening time, there’s no hard dollar costs in Year 1 as the credit union conducts an internal review and designs process improvements.  In Year 2 and beyond, the efficiencies are expected to lower costs and drive some additional new accounts, thereby increasing ROA.

Beyond looking at each strategic initiative, notice that now the aggregate expected impact of all initiatives can begin to be understood.  If all or a significant number of initiatives have negative ROA impacts, that can be an indication of needing to consider other, offsetting strategies to generate additional revenue.  Or, it may make sense to accept lower earnings for some period.  That would be important to recognize and to make sure that everyone, including the board and management, is on the same page with the expectation so there are no surprises.

After completing this exercise, board members and management can be better prepared to review the budget with a high-level expectation for how it may look.  If projections don’t align with expectations, more “why” questions can be asked and differences understood.  As financial results occur and new budgets are created, this can be a great tool to keep as a reference.  Strategic initiatives can be reassessed for what was originally expected versus what actually happened, and to determine what changed and why.