cost optimization in finance; Next-Gen IA
cost optimization in finance; Next-Gen IA

How CFOs Can Solve The Inflation Puzzle

Jim DeLoach, Managing Director Host, The Protiviti View

As concerns over the rise of economic inflation escalate, a stark reality emerges: There are legions of executives—even board members—who have never had to cope with persistent inflation. A rare environment of this kind presents a unique opportunity for leading CFOs to elevate scenario planning activities and other next-generation finance capabilities with the objective of contributing an enterprisewide solution to a puzzling challenge with numerous moving pieces.

While it’s tempting to harken back to the 1970s and early 1980s for insights on responding to soaring prices, that would be a mistake. The current environment—and the role of the CFO—fundamentally differ from what they were four decades ago. The types of consumer demand shifts, supply chain disruptions, tight labor markets, demographic makeup and other factors driving inflation higher in today’s markets did not exist in 1982. Nor did a 100-year pandemic event with its various complications and aftereffects. These differences in the dynamic are contributing not only to inflation, but also to volatility and unpredictability.

Business moves at a much faster pace today given the global, interconnected and data-driven manner in which companies operate. Corporate finance groups have access to powerful systems, brilliant algorithms and vast pools of data to sharpen their forecasts and scenario planning. Finance leaders rely on these resources to shape corporate strategy around technology investments, supply chain resilience, talent management and even organizational culture, in addition to more traditional matters such as product costs and below-the-line expenses and the ability to absorb or pass those along to customers.

CFOs will need to deploy all of the next-generation approaches and tools in their quivers to address the multifaceted challenges that inflation poses to their organizations, regardless of industry. Examples of key challenges include:

  • Working capital management pressures: High prices raise pressing questions concerning working capital: How much inventory are we willing to carry as warehousing costs increase? What’s our breaking point? What’s our exposure to rising interest rates? How do we balance working capital management requirements with the need to satisfy customer demand? What’s the optimum cash position needed to support operations and take advantage of discount opportunities given the deterioration in purchasing power?
  • Trading partners’ credit risks: Customers and suppliers grapple with the same inflationary pressures and working capital management challenges, which can create a drag on their profitability. Moreover, these issues can impede a customer’s ability to pay and a supplier’s ability to deliver.
  • Pricing strategy: Businesses have the option to pass along higher costs of manufacturing and talent to customers by raising prices. This response can work well—until it doesn’t. When prices become too high, customers reduce purchasing activity, eating into profit margins. Or they may choose to take their business elsewhere. CFOs face a tall task in pinpointing the breaking point in price increases. Also, there is the challenge of aligning sales management with pricing strategy and concessions, not to mention keeping the strategy current with changing inflation rates.
  • Workforce risks: Inflation is an equal opportunity risk in that it affects everything with a value assigned to it, from the purchasing power of monetary assets to the cost of commodities and raw materials to defined benefit plan performance to the cost of talent. When annual compensation increases 3-5% but inflation hovers at 7-8%, employees are effectively experiencing a pay cut—this is less than optimal during a long-term talent crunch which has given substantial leverage to employees.
  • Procurement strategy: Persistent inflation necessitates different approaches in negotiating pricing with suppliers. For example, proposed price increases should be traced back to specific inputs (including labor) and raw materials, product design should be evaluated to optimize cost builds, and price negotiation strategies should vary depending on whether long-term purchasing contracts are indexed to inflation. If hedging strategies are in play, they should be coordinated enterprisewide.

CFOs should play a decisive role in addressing these and other challenges and how they affect their organization’s overall strategy and its interrelated enabling components, including product strategy, marketing strategy, human capital management strategy, and so on. If the finance group, for example, forecasts that a product price increase ultimately could erode profit margins by 10-15%, should marketing investments be reduced by a similar amount, should the product pricing remain at current levels, should procurement revisit price negotiation strategies, or should a different lever or combination of levers be pulled?

Making these strategic determinations requires CFOs and their teams to lean on their data, predictive analytics and advanced technology tools to craft dynamic plans and contingencies that can be adapted to volatile economic swings while maintaining the organization’s overall strategy. (I’ve written in Forbes about the building blocks of these plans, which include next-generation forecasting, advanced analytics and emerging technology tools.)

A plan of action

To equip their organizations to address the quandaries sparked by inflationary pressures, CFOs should:

  • Get the data: Finance groups need access to ever-expanding collections of data sets from organizational partners, suppliers and customers. This diverse data generates real-time insights on the availability and cost of raw materials, suppliers’ pricing decisions, fluctuating logistics costs, soaring labor costs, and more. Granular, data-driven insights are especially critical during inflationary periods when the costs of similar materials, products and skills fluctuate in uneven and unexpected ways.
  • Elevate scenario planning: The data and business indicators finance groups obtain ultimately fuel scenario planning and stress-testing (e.g., projecting those breaking points where price increases reduce demand). CFOs need to leverage this information to identify the factors most sensitive to inflationary pressures and then run those drivers through various scenarios to assess implications to the business plan and analyze mitigation options. If oil prices jump another 20 percent next quarter, what does that mean for our shipping costs and how should we respond?
  • Find (and keep) finance talent: Optimizing the data, predictive analytics and technology tools required to generate—and continually regenerate—forecasts, robust scenario plans, and effective stress tests requires a next-generation finance mindset. Finance analysts need proficiency with cutting-edge tools and techniques, comfort with getting information quicker (and from further afield), and interpersonal dexterity in managing the expectations of an expanding group of internal customers and external partners. Needless to say, that requires the right talent.
  • Communicate and collaborate: Sustaining working capital requirements amid rising interest rates and price gyrations requires constant communication with accounts receivable teams and treasury partners. Sales and supply chain leaders are similarly crucial partners to optimize sales and preserve margins. Boards need to be kept abreast of changing plans, and the investment community’s appetite for information, along with often-exacting expectations, need to be managed. CFOs also should consider deepening their collaboration with appropriate external technology providers and talent sourcing partners who play an increasingly important role in supporting their initiatives to manage the organization’s inflation-related challenges.

The CFO’s role in the organization’s response to the current inflationary cycle and its resulting uncertainties boils down to communication, collaboration and—just as important—coordination. Finance groups possess the data, tools and expertise required to produce and analyze the data, indicators and information that combine to form an accurate picture of the risks inflation poses. As those scenarios and forecasts are generated and continually regenerated based on new, real-time inputs, finance should coordinate responses requiring behavioral shifts from leaders throughout the business.

It’s time for CFOs to call on their inner enigmatologist to coordinate how all of the pieces of the organization’s inflation risks and responses should click into place. CFOs should accept nothing less than an effective, sustainable enterprisewide solution. Their internal and external customers will do no less, as well.

This article originally appeared on Forbes CFO Network.

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