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Strategic Budgeting/Forecasting Questions: Connecting The Strategy

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This last entry in our 6 blog series about Strategic Budgeting/Forecasting Questions addresses creating a more thorough understanding of the connections between strategies and the budgeting/forecasting process.

Question 6 – What are other questions we should be asking?

While this may at first seem like an open-ended consideration, the goal of this question is to use a very specific approach to create more and deeper dialogue about the strategies and their reflection within the budgets and forecasts.  Very literally, we recommend asking senior management, What other questions should we be asking?  Using this approach can often bring to light those areas where concerns or obstacles may exist, creating a safe and collaborative opportunity to discuss them.

Some variations of this question may also be appropriate, such as, What are the unintended consequences of what we’re asking for?  Or, Is there something in what we’re doing that is creating a barrier to being successful with our strategic initiatives?

Asking such questions may be uncomfortable at first because it invites differing points of view and increased scrutiny of what may be the greatest challenges facing the desired strategy.  However, any initial discomfort is certainly worth the potential rewards—achieving greater buy-in and alignment with strategic directions and creating an opportunity to identify potential obstacles early.

"The point at which you address a problem is directly related to the number of viable options you will have to solve it." —Cliff Myers, 1922-2000

Of course, inviting open dialogue does not equate to an obligation to change the given strategy.  It simply better informs leaders about what may be ahead and allows the group to consider if any course changes might improve the opportunity for success.

For example, what if—through these questions—the board learned that the annual measure of success requiring the credit union to achieve a 1.00% ROA was getting in the way of being successful with the strategic initiative to remain relevant to the membership?  The board may have anticipated that the relevancy initiative would come at some cost to the credit union, but may not have recognized that the previously agreed upon measures of success might hobble that goal.  While a change could be made, it might also be an opportunity for the board to reiterate and clarify the reasons why the existing goals should continue without change.

The stakeholders have the same overall goals—a safe, sustainable, viable, and exciting organization to best serve the membership.  Trusting in that can allow for deep and honest dialogue about the road ahead.  As a final, solidifying step to ensure everyone is on the same page and has a clear vision of the expectations, credit union leadership can ask, What are other questions we should be asking?  By so doing, senior management will be better prepared to follow through and deliver on the strategic initiatives reflected within the budget and financial forecasts.

In this blog series, we explored the critical role of connecting the dots between strategic initiatives and the budgeting/forecasting process.  Specifically, we discussed the following questions:

  1. What is the expected financial direction of each strategic initiative?
  2. How are strategic initiatives represented in the budget and forecast?
  3. What key forces could impact our forecast?
  4. Are our financial measures of success handcuffing the credit union strategically?
  5. How is the budget and forecasting linking to our appetite for risk?
  6. What are other questions we should be asking?
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Strategic Budgeting/Forecasting Questions: Consider Key Forces

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This is the third entry in our 6 blog series about Strategic Budgeting/Forecasting Questions.

Question 3 – What key forces could impact our forecast?

Every good forecast should have a sound rationale and basis for the assumptions. If the current forecasting approach involves simply taking last year’s growth rates and assuming they continue, that will not be good enough going forward. A better approach is to identify key forces that could impact the budget/forecast and use this discussion as the rationale for the forecast assumptions.

It is important to understand that both internal and external forces have the ability to impact the forecast. Internal forces are largely driven by the strategic plan and initiatives set forth by the credit union, as well as the ability to execute (see the first and second blogs in this series for more).

Then there are external forces that have the ability to act as headwinds, which put pressure on the strategy, or tailwinds, which help move the strategy forward. The focus here will be on external forces. What is going on in the world around the credit union that could impact the forecast?

Start by getting decision-makers into a room and brainstorming different external forces that could impact the forecast. The list of forces can be quite extensive, so go through a process of prioritization. Group the ideas into two separate categories, headwinds and tailwinds as seen in the table below.

External Forces

The value is always in the discussion.  Take the top headwinds and tailwinds, study recent trends, and use this business intelligence to inform your forecast assumptions.  Take the potential auto sales headwind as an example.

17-06-q3-v3-dav

Source: macrotrends

Study historical data and discuss as a group. Auto sales have accelerated from 2010 to 2016. More recently, they have slowed. This trend should be incorporated into the forecast, especially on how it might impact the credit union’s strategic initiatives.

What about real estate? Are home values a key force that could impact your real estate lending and ultimately the forecast? Using the S&P CoreLogic Case-Shiller or another market source, decision-makers can understand what property values are doing in the area. If your area has experienced price increases well above national averages and prices are now above previous peaks, maybe that leads the group to assuming a slight decrease in new volume.

The combination of identifying key external forces, studying history, and having a discussion will better inform the forecast. Continue to use the what-if capabilities of your forecasting model to stress test the financial impact of changes in key market forces. Following this process will help decision-makers understand how external forces can impact the financial direction of strategic initiatives.

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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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Forecasting Considerations

Many credit unions have started their budget and, similar to prior years, stress testing key assumptions should be an important part of the budget process.

Last year, we emphasized the importance of testing out different rates of loan growth. While that continues to be an important stress test to perform, provision for loan loss (PLL) and potential pressure on the cost of funds may need special attention this budget season.

The past few years of historically low PLL could be coming to an end as many credit unions have used up excess reserves or taken on more credit risk. Credit unions should understand the sensitivity of earnings and net worth when testing different levels of PLL.

Another recent trend that could change going forward is a continued reliance on cheap non-maturity deposits to fund future loan growth. There is danger from both an earnings and liquidity perspective in budgeting for the same checking and regular share growth experienced over the past several years. More credit unions have started increasing deposit rates of late as share growth has slowed while loan growth has increased. We encourage credit unions to stress test their ability to handle an increase in deposit rates or pressure from the cost of funds mix changing to more certificates and money markets.

Stress testing continues to be a cornerstone in effective planning. The results of such stress tests can help ALCOs and boards better understand the sensitivity of the earnings and inform the credit union what it may want to do going forward.