One of my biggest challenges as a Finance executive at companies like Moveworks, ArcticWolf, and Palo Alto Networks was dealing with financial forecasting “buffer”. While “buffer” may not be a GAAP or IFRS technical term, I promise you that “buffer” does in fact exist at every enterprise. What is it? Financial forecasting "buffer" refers to the additional amount of money that is included in a forecast to account for unforeseen expenses or to ensure that financial targets are met.

Why do CFOs and FP&A teams rely on “buffer” for financial forecasting?

There are a few reasons for why “buffer” is needed for financial forecasting:

• For publicly traded companies, the management team wants to exceed all key financial targets committed to the board and Wall Street 
• Especially in the current macro-economic environment, no one, particularly finance teams and budget owners, want to exceed their expense forecast and land in trouble with their CEO, CFO, and COO
• Unforeseen expenses happen no matter how hard you plan, such as an unexpected lawsuit or large sales deal that closes earlier than expected that requires commission payouts

Enterprises also benefit from having a financial forecasting “buffer”. Imagine a new strategic initiative (e.g., M&A, IPO readiness, R&D initiative for new product launch) that demands urgency but is not budgeted near term. Or, another example would be needing to accelerate sales hiring and/or marketing initiatives to quickly grab market share from a competitor that has unexpectedly popped up on the radar.

Let’s review some examples of how “buffer” works for enterprise financial forecasting.

How financial forecasting “buffer” works for public companies

Public companies get rewarded when they are able to “beat and raise”. These enterprises will have to beat their current quarter financial targets and then, reset and raise their next quarter’s and next year’s targets compared to Wall Street consensus.

Scenario #1 - Tracking behind on hiring, particularly R&D, and likely to beat or exceed revenue targets

Budget owners, hiring managers, and FP&A teams tend to be optimistic about hiring plans. “Of course, we will have all of these jobs filled by the end of the quarter.” Life happens. And then, there are many “to be hired” openings that are not filled at the end of the quarter.

This means that the FP&A is stuck with excess dollars (over and above the “buffer”. Unfortunately, FP&A usually finds this out in month 3 of the quarter. Why? Because accounting closes are slow and budget owners avoid wanting to give up any of their budget they are not using.

At this point so later in the quarter, there are few options for FP&A to course correct to help the company land their expenses and beat Wall Street’s expectations for operating profit targets. Hiring cannot be accelerated in the last few weeks of the quarter to have a meaningful expense impact. What will happen is companies end up spending money on unbudgeted items that may not help with meeting long term profitability goals. Some examples:

• Purchase capital equipment today that is not needed for 6-9 months
• Spend more on unbudgeted Linkedin ads expenses
• Spend excessively on unbudgeted employee SWAG and gifts
• Host an offsite event with expensive food and beverages that was not needed

Finance teams perform budget versus actuals and forecast vs actual exercises throughout the quarter. When the size of the corporate “buffer” starts to steadily increase towards the end of the quarter, that is when companies make suboptimal choices to burn through “buffer” (i.e., waste dollars) so they land or exceed by 2-3% their published financial targets to Wall Street.

Scenario #2 - Tracking behind on hiring and unlikely to beat or exceed revenue targets

In this scenario, the company is nervous if they will meet or exceed Wall Street operating targets. The company needs to have a good understanding of their corporate “buffer” and what levers they can activate. Here is what levers a company will typically pull:

• Push out start dates of candidates that have accepted offers to next quarter
• Defer pending termination to next quarter to avoid severance expense for this quarter
• Dial down on bonus related expenses for corporate bonuses tied to revenue

Scenario #3 - Tracking ahead of forecasted headcount costs and unlikely to beat or exceed revenue targets

Similar to Scenario #2, the company should be nervous and need to have a solid understanding of their corporate “buffer” and what levers they can activate. What I have typically seen is an enterprise will:

• Push out start dates of pending candidate start dates to next quarter
• Defer pending termination to next quarter to avoid severance expense for this quarter
• Dial down on bonus related expenses for corporate bonuses tied to revenue
• Terminate and/or push out contractors
• Initiate a “no travel” ban for non-quota bearing employees
• Review all headcount related personnel expenses for potential reductions

 
How financial forecasting “buffer” works for private companies

Private companies do not have to deal with Wall Street expectations, however, they are answerable to their board of directors and their valuations are tied to efficient growth. 

Scenario #1 - Tracking behind on hiring, particularly R&D, and likely to exceed revenue targets

In this scenario, the Board has signed off on investing, per the corporate forecast. If the company were to exceed operating profit, this would suggest they are missing out on investing ahead of growth. With a solid understanding of their forecasting “buffer” (i.e., excess dollars related to under hiring), the company could re-allocate some of all of the “buffer” to initiatives to drive growth, for example:

• Pull forward quota bearing  hires from next quarter to current quarter
• Invest ahead in marketing programs that could result in more leads to drive higher bookings
• Invest in un-funded R&D initiatives to accelerate product roadmap to drive more sales

Scenario #2 - Tracking behind on hiring and unlikely to exceed revenue targets

This is a tough scenario. If the company believes this miss is temporary (e.g., a large deal got pushed to next quarter for uncontrollable reasons), the company may choose to continue to invest in planning hiring and other initiatives. However, if the company believes this is due to macro or industry headwinds with near term and next quarter impact to revenue targets, FP&A will need to slam on the brakes with expenses. Scenario planning and modeling exercises kick-off for bookings / revenue, expenses, and cash burn before actions are taken. At this point, some levers that can be taken include:

• Terminate and/or push out contractors
• Initiate a “no travel” ban for non-quota bearing employees
• Ban all company or department outings
• Reduce meals, snacks, and other discretionary spend
• Evaluate all non-essential SaaS spend, particularly those that were employee driven with credit cards

We reviewed scenarios for both publicly traded companies and privately held companies to understand how FP&A teams manipulate financial forecasting “buffer” to either reduce the risk of missing Wall Street and Board financial targets, or to invest ahead in funded and unfunded projects. 

Should there be a corporate financial forecasting “buffer”? How much of a corporate “buffer” is too much? What alternatives do FP&A teams have to get more visibility sooner and course correct before making sub-optimal decisions to land the quarter? My take - it’s not bad as long as the company knows exactly how much buffer there is at any given time in the quarter. 

Reach out to me on LinkedIn or request a demo  to find out more how Precanto can help with corporate “buffer” in financial forecasting.