In September 2014, when most companies were building their 2015 budgets, the euro was worth $1.25. By the time the books were being closed on January 2015, it was down to $1.05. By mid-September 2015, as the third quarter was ending and the 2016 budget season was in high gear, it had recovered to $1.14. So what price will the dollar be in 2016? The answer is really anybody’s guess and that’s the point — we live in a world of uncertainty and hence unpredictability.
This pattern was also seen with most other major currencies, so it was no surprise that the strengthening of the dollar became the favored explanation for earnings variances for much of 2015.
For years now, CFOs have dealt with volatility in their earnings forecasts. But as they prepare budgets for 2016, the level of uncertainty will be on the rise again. Companies are not only dealing with unusually low oil prices (a good thing for most but not all companies) and an uncertain U.S. interest rate environment. They’re also coping with continued exchange-rate volatility that is becoming a much more significant factor as companies increasingly globalize their operations. So how should CFOs approach budgeting for 2016? There are four ways:
Accept Reality. In their hearts, CFOs have known for years that very detailed annual budgets predicated on a static set of assumptions are useless at predicting future business performance — never mind serving as a rational basis for allocating resources. Now is the time to acknowledge this reality and move to implement a set planning and budgeting process that embraces, rather than ignores, uncertainty and volatility. By acknowledging that uncertainty and volatility in today’s business environment is the “norm,” you can plan accordingly.
Create Flexibility. Develop plans and budgets that can be rapidly adapted to changing market conditions during the year. By moving from a static annual budget process to a more dynamic rolling process, where plans are frequently updated to reflect the ever-changing reality and adapting resource allocation plans accordingly, you can better anticipate and react to volatility.
Embrace Uncertainty. Replace budget detail with scenario and sensitivity analysis. By modeling business performance under a range of different scenarios, CFOs can provide business leaders with a “playbook” that defines the actions they should take to either minimize the negative impacts of volatility or capitalize on the positive effects. For example, changing exchange-rate scenarios can allow nimble companies to re-prioritize marketing and promotional programs if effective scenario planning and performance monitoring processes are in place. Similarly, sensitivity analysis can be applied to key elements of the business, such as raw material costs, labor costs, and product pricing to evaluate the impact of exchange-rate volatility.
Optimize Global Operations. Beyond changing planning processes to the new reality, many companies are adapting their operating models to adjust to a volatile global marketplace. For example, by aggressively pursuing digital-technology-driven productivity improvements, organizations can create a cushion against volatility by dynamically routing work to the most cost-effective locations and getting the most out of global supply chains. We are also seeing a significant increase in the use of strategic cost management techniques like zero-based budgeting (ZBB), which place a laser-like focus on indirect spending levels to optimize expenses and assure cost efficiency. This includes, among other things, actively managing the drivers of demand to ensure that both drivers of cost — demand and price — are managed.
Exchange-rate volatility is not a new phenomenon. But its impact is increasing as companies make, sell, and serve across global markets. As CFOs lock down plans for 2016, the only certainty is that their assumptions about exchange rates will be wrong. A willingness to accept this reality, plan for it, rapidly identify when their planning assumptions no longer make sense, and then act with speed and confidence will distinguish the winners from the losers. The good news is that CFOs have better data and more sophisticated tools than ever before to effectively manage uncertainty.
Sidebar: The Bottom Line on the Impact of a Rising Dollar
- The value of overseas earnings in dollar terms diminishes.
- The cost of U.S.-made products increases in local currency terms.
- Margins are pressured as foreign competitors exploit cost advantages.
- Hedging strategies become risky in times of volatility.
- The U.S. consumer benefits as import prices fall.
- Good business is good business regardless of the exchange rate.
David Axson is global Leader for Accenture’s CFO strategies practice.