SUMMARY AML CHAPTER 7

STEP 4: DEVELOP THE FORECAST OF OPEX AND CAPEX

Once managers have agreed on the level of resource supply for future periods, the
financial implications can be calculated simply and quickly. We refer to the
estimated financial spending in a future period as the budget for that period.
At the end of step 3, the company has estimated the quantity of each type of
resource it has agreed (or expects) to supply in a future period. The company
already knows from building its TDABC model (described in the appendix for
Towerton Financial) the cost of supplying each unit of resource (summarized in
Figure 7-8).
Before running the model, the planners should adjust the resource unit costs for any
anticipated price changes. In this way, the cost and spending forecasts will reflect
future expectations rather than historic actuals. After that, the company multiplies
this value by the quantity of each type of resource to be supplied during the
forecasting
periods.
This
multiplication
yields the forecast
(budgeted) cost of
supplying
the
quantity of each
resource
type,
shown in the last
column of Figure
7-8.

The Budget arrives from a simple cross-multiplication process: multiply the quantity
authorized for each resource type by the resource's cost per unit. Computers do
multiplication, even of large arrays, extremely quickly, inexpensively, and
accurately. The result is a budget that has been derived quickly and analytically
from the sales and operating plan, rather than imposed by fiat or through power
negotiations.
The process described here is exactly analogous to material resource planning
(MRP), a systems that took detailed forecasts of the production of each product and
"exploded" them up to a total demand for materials and component parts during
the production period. The resource capacity planning process, described in steps 1
through 4, extends the MRP model to forecast all resource capacity demand. It
explodes the detailed sales and operating plans into the total demand for all
resources: employees, equipment, facilities, and distribution.
The spending to supply employees and to operate equipment and facilities is
generally classified as operating expenses (OPEX). The spending to add equipment
and technology capacity, and to acquire space to support growth in future

operations, is considered a capital expenditure (CAPEX). Financial accountants

determine the type of spending.
Forecasting Discretionary Spending
Before concluding the budgeting process, the company needs one additional set of
estimates: the forecasts of the level of discretionary spending on items such as
research, development, advertising, promotion, training, and, of course, strategic
initiatives.
The forecast spending on these discretionary items does not bear a tight causal
relationship with sales and operating levels, and therefore it requires a parallel
calculation along with the quarterly update of revenues. The spending on such
discretionary items remains a judgment call by experienced executives, and not a
decision that can be automated through an analytic model. Financial accountants
classify much of this discretionary spending as a general and administrative
expense, although we argue, in Chapter 4, that spending on strategic initiatives
should be classified as a new income statement line item, STRATEX.
The authorization process for spending on projects and initiatives should be
revisited at least quarterly, in light of the most recent actual information and the
forecast economic and competitive situation.
STEP 5: CALCULATE PROFITABILITY BY PRODUCT, CUSTOMER, CHANNEL,
AND REGION
In addition to the total level of expected spending for the forecast period, the
TDABC model supplies the detailed profit-and loss statement (P&L) for each product,
customer, and region. By going back to the detailed sales and operating plan (Figure
7-5), the model automatically attributes the supply and cost of each resource type
to the transaction, product, or customer that triggered the demand.
Figure 7-9 shows Towerton's pro forma product-line profit and loss statement for the
forecasted period. If Towerton is using a rolling five-quarter forecast, it can follow
the five steps of this chapter to generate forecasted P&L's, like Figure 7-9, for each
of the next five quarters.

SUMMARY
Companies translate their strategic intent into detailed operating plans through a
disciplined, integrated five-step process.

Step 1 : quarterly sales forecasts for the next several

periods.

Step 2 : planners translate high-level sales forecasts into

detailed sales and operating plans,

Step 3 : the detailed sales and operating plans are

converted, through a time-driven activity-based cost model,
into the forecast demand for capacity of the company's
primary resources.
Step 4 : planners simply and accurately translate the
authorized level of resource supply into budgeted operating
and capital expenses for the upcoming periods,

Step 5 : the pro forma profit-and-Ioss statement, in

aggregate for the business unit or company and by product,
service, customer, channel, and region.

This series of logical and tightly linked steps provides translation of high-level sales
growth targets into detailed plans for authorizing resource capacity and estimating
the near-term operating profitability, by products, customers, and regions, from the
strategic plan.