A Framework for FP&A

A Framework for FP&A

By Karl Kern, Founder/President, Kern Analytics LLC

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frameworkA Chart of Accounts as an FP&A Framework

In previous articles, I wrote about ways to improve financial reporting through financial planning and financial analysis.  A foundation for financial reporting is a chart of accounts.  A chart of accounts also can serve as a framework for FP&A.

A chart of accounts serves as a database containing records like account elements, account names, and account numbers.  Examples of account elements are assets, liabilities, equity, revenues, and expenses.  Examples of account names are cash, accounts payable, common stock, merchandise revenue, and cost of goods sold.  Examples of account numbers are assets starting with the number one, liabilities starting with the number two, equity starting with the number three, revenues starting with the number four, and expenses starting with the number five through nine.  These records serve as a foundation for the communication of financial statements however these records serve two additional purposes.  The first purpose is to establish a framework for financial planning.  The second purpose is to establish a framework for financial analysis.

A Framework for Financial Planning through Precision

A chart of accounts establishes a framework for financial planning through precision.  Precision within financial planning through a chart of accounts focuses on account names.  The use of account names can establish a descriptive manner in how businesses expect to earn income.  Earning income from revenues can be described through account names like audit fees, jewelry sales, membership fees, out-of-pocket reimbursements, and smartphone sales.  Earning income from expenses can be described through account names like accounting services, fashion show production, freight from drop shipments, LinkedIn advertising, and office stationery. Using precision through account names in financial planning can initiate the proper recording of transactions.  Using precision through account names in financial planning also can initiate the proper evaluation of effort toward earning income.

A Framework for Financial Analysis Through the Process

A chart of accounts establishes a framework for financial analysis through the process.  The process within financial analysis through a chart of accounts focuses on account names.  The use of account names can establish the amount of effort taken.  Using account names that describe broadly, for example, miscellaneous expenses will require more effort to learn about the nature of transactions.  Using account names that describe narrowly, for example, laboratory equipment, will require less effort to learn about the nature of transactions.  Is describing broadly better than narrowly or vice versa?  The answer is neither.

Describing Broadly or Narrowly?

Describing broadly establishes a “top-down” approach to solving financial problems.  Describing broadly can be used to focus on elements like revenues expenses, assets, liabilities, and equity.  Elements like these can establish a starting point for identifying strengths and weaknesses in the financial health of organizations.  Describing narrowly establishes a “bottom-up” approach to solving financial problems.  Describing narrowly can be used to focus on elements like iPhone sales, Facebook advertising, printer cartridge supplies, California sales taxes payable, and Class A common stock.  Elements like these can establish a starting point for making better decisions on specific activities that affect the overall financial health of organizations.

FP&A establishes the foundation for thinking and learning about how processes affect outcomes.  These actions can be guided by broad and narrow framing.  In order for FP&A to add value toward these actions, it must take an active role in establishing a framework through the chart of accounts.