Some Emotional Drivers

The following points are some of the emotional drivers you would use to sell the need to streamline the annual planning process to the SMT:

1. Annual planning is wasteful There is a huge cost associated with the annual plan—ensuring you estimate on the high side, as costs motivate the SMT and the board.

   Finance team members lose months and work many late nights and weekends, producing an annual plan that is wrong.

   The board, the SMT, and all levels of management are tied up in arguments discussing a period no one can predict.

2. Poor allocation of resources Rational budget holders become dysfunctional requesting funds they do not need but feel they should have them just in case. Resources are thus locked away in budget holder slush funds.

   Many new opportunities that become available are not taken up, as they were not funded in the budget. The funding is thus not adaptable to the changing conditions.

   The finance team and budget holders are skilled staff that could be doing more meaningful activities.

3. Undermines reporting The monthly budgets, if set from the annual plan, create meaningless month-end targets. The June budget turning out to be closer to September's numbers and September's budget more relevant to November, and so on. The corrupted budgets lead to meaningless variance commentary (e.g., “It is a timing difference;” “It was not meant to happen this month”).

   I always say to attendees at my workshops, if you set your month-end budgets from the planning round, you have committed one of the greatest mistakes since Luca Pacioli invented double entry bookkeeping.

Costing the Annual Planning Process

In order to create a change in the way the SMT, board, and management address the annual planning process, you need to establish what is the full cost of the annual planning process, including CEO, CFO, SMT, the budget holders, and the accounting and planning staff masterminding the process.

Based on a costing for a 500 FTE organization, I have estimated that the annual cost is between $1.2 million and $1.7 million a year. As I like to say to senior management, “If you do nothing about this, you will be investing $12 million to $17 million over the next 10 years.” Exhibit 9.1 illustrates how the sum was calculated. The times are estimates and show what a 500 FTE organization may be investing in its annual plan preparation.

As used in earlier costings, I use 42 productive weeks a year for the finance team and budget holders, having removed holidays, training, and sick leave. I take off another 10 weeks for the CFO, SMT, and CEO to account for time spent traveling and in numerous meetings.

Separation of Targets from the Annual Plan

It is so important to tell management the truth rather than what they want to hear. Boards and the senior management team have often been confused between setting stretch targets and a planning process. Planning should always be related to reality. The board may want a 20 percent growth in net profit, yet management may see that only 10 percent is achievable with existing capacity constraints.

The key is to remove any deliberate manipulation related to performance bonuses. In Chapter 20, Performance Bonus Schemes, I point out that any performance bonuses should be paid on performance compared to the market rather than to an annual plan. We want management to be extracted from the annual charade of making a target easy so their bonus is secured.

By reporting a gap, we are saying to the board that based on expected customer demand, the existing products/ services, and the relevant prices there is a shortfall. “Please help us find the missing profit.” The board then might need to acquire some profit by purchasing a new subsidiary or bring forward the development of a new product, increase prices, and so on.

Exhibit 9.2 shows where management have forced the plan prepared in March to meet the target set by the board. Each subsequent reforecast continues the charade until in the final quarter reforecast, performed in March the following year, the truth is revealed. In reality, the truth was always a shortfall, as the dark line in Exhibit 9.2 illustrates.

Bolt Down Your Strategy Beforehand

Leading organizations always have a strategic workshop out of town. This session should be anticipated with a positive attitude. Normally, board members will be involved, as their strategic vision is a valuable asset. These retreats are run by an experienced external facilitator. The key strategic assumptions thus are set before the annual planning round starts, and board members also can set out what they are expecting to see.

Great management writers, such as Jim Collins, Tom Peters, Robert Waterman, and Jack Welch, have all indicated that prominent organizations are not great because they have the largest strategic plan. In fact, it is quite the reverse; the poor-performing organizations are the ones that spend the most time in strategy and the dreaded annual planning process.

Jack Welch, in his book Winning,³ talks about how he stopped business units writing large strategic documents and delivering drawn-out presentations. He forced all strategy plans to fit on to five slides. I have set out my interpretation of his slides and also include the thoughts from Jim Collins (see Exhibit 9.3).

Avoid Monthly Phasing of the Annual Budget

As accountants, we like things to balance. It is neat and tidy. Thus, it appeared logical to break the annual plan down into 12 monthly breaks before the year started. Since we planned monthly, it seemed logical that July's column was July's number. In reality, July's numbers represented November's actuals and the November budget was closed to February's actuals. In other words, although the 12 columns added up to a year that maybe proved to be a reasonable guess, the monthly splits are radically wrong. If you can get your monthly splits right, you are in the wrong job, as you should be making money out of your knack of seeing into the future.

In the annual plan, we should only present quarterly indicative splits concealing the month columns. See Exhibit 9.4 for a suggested one-page summary format.

The monthly targets should be set a quarter ahead using a quarterly rolling forecasting process, which is discussed in Chapter 16. This change has a major impact on reporting. We no longer will be reporting against a monthly budget that was set, in some cases, over 12 months before the period being reviewed.

If you get the monthly budgets approved in the annual planning process, you will have created a reporting yardstick that undermines your value to the organization. Every month in the organization you will make management write variance analyses that I could do just as well from my office. “It is a timing difference,” “We were not expecting this to happen,” “The market conditions have changed radically since the plan,” and so forth.

The Annual Plan Does Not Give an Annual Entitlement to Spend

The annual plan should not create an entitlement; it should be merely an indication, with the funding based on being allocated on a quarterly rolling forecasting and planning regime, a quarter ahead each time (see Chapter 16). Asking budget holders what they want and then, after many arguments, giving them an “annual entitlement” to funding is the worst form of management we have ever presided over.

Organizations are recognizing the folly of giving a budget holder the right to spend an annual sum, while at the same time saying that if you get it wrong, there will be no more money. By forcing budget holders to second-guess their needs in this inflexible regime, you enforce a defensive behavior, a stockpiling mentality. In other words you guarantee dysfunctional behavior from day one!

The key is to fund budget holders on a rolling quarter-by-quarter basis. In this process, the management asks, “Yes, we know you need $1 million and we can fund it, but how much do you need in the next three months?” At first the budget holder will reply, “I need $250,000 this quarter,” to which is replied, “Pat, how is this? Your expenditure in the last five quarters has ranged between $180,000 and $225,000.” “Pat, you are two team members short and your recruiting is not yet underway; be realistic. You will only need $225,000, tops.”

It will come as no surprise when a budget holder is funded only three months ahead that the funding estimates are much more precise and there is little or nowhere to hide those slush funds.

Commit the Budget Committee Commits to a “Lock-up”

It is best to have a small “budget committee,” comprising the CEO, two GMs, and the CFO. Rotate the GMs each year so that all are involved over time. The GMs will, of course, be part of their relevant annual plan submission.

This committee sits in a lock-up for between three and five days. It is important to book, well forward, in the diaries of the budgeting committee the key dates when they need to be in committee to interview budget holders.

You need to ask the budget committee whether it would rather have three days or three months of pain. I cannot conceive of any CEO, who is a modern thinker, who would not take up the offer.

The role of the committee is to interview all budget holders about their annual plans for their team next year, including justifying their annual plan forecast, and the nonfinancials (e.g., staff succession, staff rotation).

During the three-day lock-up, each budget holder has a set time, up to about 45 minutes, to do the following:

• Discuss their financial and nonfinancial goals for the next year.
• Justify their annual plan forecast.
• Raise key issues (e.g., the revenue forecast is contingent on the release to market and commissioning of products __and __).

Budgeting at Category Level Rather Than Account Code Level

It is far better to budget at category level rather than account code level. A forecast is rarely right. Looking at detail does not help you see the future better. In fact, I would argue that it screens you from the obvious. Planning at a detailed level does not lead to a better prediction of the future. A forecast is a view of the future; it will never, can never, be right. As Carveth Read,⁴ said “It is better to be vaguely right than exactly wrong.” Planning a full final year in detail, in the dynamic world we live in, has always been, at best, naïve, and at worst, stupid.

Although precision is paramount when building a bridge, an annual plan need only concentrate on the key drivers and large numbers.

Following this logic, it is now clear that as accountants, we never needed to set budgets at account code level. We simply do it because we did it in the previous year. You can control costs at an account code level by monitoring trend analysis of actual costs over 15 to 18 months.

We therefore apply Pareto's 80/20 principle and establish a category heading that includes a number of general ledger codes, as shown on Exhibit 9.5.

Helpful rules that can be used to apply this foundation stone include:

• Budget for an account code if the account is over 10 percent of total expenditure or revenue—for example, show revenue line if revenue category is over 10 percent of total revenue. If account code is under 10 percent, amalgamate it with others until you get it over 10 percent. See Exhibit 9.5 for an example.
• Only break this rule for those account codes that have a political sensitivity.
• Limit the categories that budget holder's need to forecast to no more than 12.
• Select the categories that can be automated, and provide these numbers.
• Map the G/L account codes to these categories—a planning tool can easily cope with this issue without the need to revisit the chart of accounts.

Getting It Wrong Quicker

The only thing certain about an annual target is that it is certainly wrong; it is either too soft or too hard for the actual trading conditions. If we all agree that we spend months of effort getting a number wrong, then you should agree with me that we need to get it wrong quicker, but we still need a reasonable estimate.

In the past, we have given budget holders three weeks to produce their annual plan—yet they have done it all in the last day or so. They have proved to us it can be done quickly.

If we apply the foundation stones described earlier, you will have taken the politics out of annual planning—why would budget holders spend a long time fighting for an annual plan allocation if you have told them it is not an entitlement to spend?

One way to reduce the time spent in this area is to start the annual planning cycle off later. I recommend the second week of the ninth month—that is, for a December year-end, start the annual planning in week 2 in September.

The CEO needs to make a fast time frame nonnegotiable in all communication with staff. As long as the foundation stones are in place and the CEO has agreed to get behind a fast annual planning process, the program, as set out in Exhibit 9.6, will work.

From the memo that goes out to invite budget holders to the annual planning workshop, the address of the attendees at the workshop, and the daily chasing up of the laggards during the three days budget holders have to complete their annual plan, the message is clear: We want a fast, light-touch annual plan. Fast ensures the annual plan is completed in less than two weeks, and light touch avoids unnecessary detail.

As part of this foundation stone, common templates are established to replace the myriad spreadsheets. One such common template is the payroll worksheet that shows budget holders all their staff and their salaries, start date, leaving date if known, and so on (see Exhibit 9.7). This tool is discussed later on.

Built in a Planning Tool—Not in a Spreadsheet

As stated in Chapter 4, Technologies You Must Have Before You Upgrade the G/L, there is no place for a spreadsheet in forecasting, budgeting, and in any other core financial routine.

Acquiring a planning tool is the first main step forward, and one that needs to be pursued not only for the organization's future but also for the finance team members' future careers.

It has never been a better or easier time to do this. Planning tools are more affordable, many are cloud based, and they can work with any general ledger. I consider it unprofessional for qualified staff to be working with spreadsheets over 100 rows. If not convinced, please reread the first section of Chapter 4.

Plan with Months that Consist of 4 or 5 Weeks

The calendar in use today can be a major hindrance in forecasting. With the weekdays and number of weekend days, in any given month, being different from the next month, forecasting and reporting can be unnecessarily compromised. Closing off the month on a weekend can make a big positive impact in all sectors.

Forecasting models should be based on a “4, 4, 5 quarter”; that is, two four-week months and one five-week month are in each quarter, regardless of whether the monthly reporting has moved over to this regime. Calculating and forecasting the following items then becomes easier:

• Revenues. For retail, you either have four or five complete weekends (the high-revenue days).
• Payroll. You have either four weeks of salary or five weeks of salary.
• Power, telecommunications, and property-related costs. These can be automated and be much more accurate than a monthly allocation.
• Monthly targets. You can simply adjust back based on calendar or working days.

Simply design the model so that smoothing back to the regular calendar can be removed easily when you decided to migrate reporting to 4- or 5-week months.

To make progress in this area, I recommend to that you contact your general ledger supplier and ask, “Who is a very sophisticated user of this general ledger and who uses 4, 4, 5 reporting months?” Arrange to visit them and see how it works for them. Ask them, “Would you go back to regular calendar reporting?” Most are likely to give you a look that says, “Are you crazy?”

Hold a Focus Group Workshop

As explained in the section The Power of the Focus Group in Chapter 2, a focus group needs to be formed as part of the selling change process. We need the oracles in the business units to discuss what the annual planning default future looks like and agree that they do not want it. The focus group workshop is important for a number of reasons:

• Many people will doubt the organization's ability to move from three to four months to two weeks, and we need to ensure that all likely objections are aired in the focus group workshop.
• We need to reengineer the annual plan process using Post-it notes, as discussed in Chapter 10.
• The foundation stones need to be understood, agreed on, and put in place early in the project.
• A green light from the focus group will help sell this concept to the SMT.
• The focus group will give valuable input as to how the implementation should best be done to maximize its impact.

The proposed agenda for the focus group is set out in Exhibit 9.8. The suggested attendees would include: budget committee, selection of business unit heads, all management accountants, and a selection of budget holders. You will need an event secretary to document agreements, two laptops, a data show projector, and two whiteboards.

The Post-it reengineering exercise is the same as the month-end process reengineering. Please see Chapter 10, Lean and Smarter Work Methods, on how to run a Post-it reengineering session.

Forecasting Demand by Major Customers by Major Products

If you have 200 products and 2,000 customers, how do you get to a reasonably accurate forecast? The answer lies in applying Pareto's 80/20 rule to the sales forecasting process. Sales need to be forecast by major customers and major products. The rest of the customers and rest of the products should be put into meaningful groups and modeled based on the historic relationship to the major customers' buying patterns. See Exhibit 9.9 for a suggested format.

Many organizations liaise with customers to get demand forecasts, only to find them as error prone as the forecasts done in-house. The reason is that you have asked the wrong people. You need to get permission to meet with the staff who are responsible for ordering your products and services.

The lesson here is that if you want to forecast revenue more accurately, you can do this by delving into your main customers' business, by asking them on a quarterly basis, “Whom should we speak to in order to get a better understanding of your likely demand for our products in the next three months and the next five quarters?”

James Surowiecki wrote that⁵ “a large group of people are often smarter than the smartest people in them.” Hence the term wisdom of the crowd was born. In other words, a group's aggregated answers to questions that involve quantity estimation have generally been found to be as good as, and often better than, the answer given by any of the individuals in the group. Involving a “crowd” in planning and forecasting can have a major positive impact on the process because:

• A great deal of trend information is being noted by those at the workplace, such as unsold products that are piling up, products that are being returned, and customer comments.
• Groups are less motivated to forecast what management wants to see.
• A small group of forecasters can only process a tiny fraction of the information available, whereas a crowd can take in an almost unlimited “harvest of data.”
• Experts tend to have a bias of optimism, especially if they are looking at sales from inside the company rather than from the customer perspective.

Resistance from “experts” is likely when you suggest using the wisdom of the crowd in place of their forecast. To convince them, you copy the practice used by Best Buy, an American multinational in consumer electronics. Suggest two forecasts: theirs and one by selected sages from around your business. Ask the sages to forecast sales for the whole organization based on what they are seeing in their areas. You can tell them, “We have prepared some historic data for you and limited the forecast to some key lines and the rest is summarized in groups. Please place your forecast in the system. If your forecast turns out to be the most accurate, you will win a weekend for two at ____ resort.”

Each quarter, you then disclose the experts' forecast versus actual and the wisdom of the crowd versus actual. I predict that the experts will want to duck for cover after a couple of forecasts highlight their inaccuracies. They will ask, even plead, “Please put our forecast in with the wisdom of the crowd.”

The wisdom of the crowd has implications on the design of the planning tool. You can expect to accommodate possibly 20 versions of the revenue forecast and then average them. This, however, should not be a problem because you are not forecasting revenue by each line and by each branch.

Required Prework

Before the two-week lean planning cycle starts, much prework has to be performed by the management accountants responsible for overseeing the planning model. The prework includes:

• Amending the existing model to incorporate the changes in this paper
• Ensuring that the sales forecast, using the practices already discussed, appears reasonable
• Inserting the current personnel details (name, title, salary) into the payroll section of the model
• Calculating all categories that are to be based on historic trends

Accurately Forecasting Personnel Costs

Payroll often represents 30 to 60 percent of total costs, depending what sector your organization is in; thus, it is worth some extra effort to get a reasonable forecast.

Accurate forecasting of personnel costs requires analysis of all current staff (their end date if known, their salary, the likely salary review, and bonus), and all proposed new staff (their starting salary, their likely start date). This is done by each manager, who reviews a prepared schedule of current staff with the salary field populated by personnel from the most recent payroll records.

Budget holders put in a leaving date if known, their likely salary review with start date, and any possible bonus. For new staff, budget holders enter starting salary and their likely start date. No one needs to show managers the monthly and quarterly figures. The model can get it right. They simply have to get the best estimate of who will be working that year and the likely salary. Exhibit 9.7 shows an example of personnel cost forecasts.

Too many errors occur when budget holders are simply given last month's payroll total to use as a basis for annual planning. By using this number, you have multiplied the long service leave paid to employee ___________ last month by 12. At the same time, you have not recognized that two staff positions were not included. Many of us have made this error.

After you have the correct salaries and wages, you can model any employment taxes paid by your organization. Then, forecast the total likely employment costs because you will have an idea about what total costs are permissible, and you can deduce the temporary, contract, and interns costs (see Exhibit 9.10). Exact numbers for these costs are not possible, no matter how much time is spent on them. In fact, the amount flexes all the time: If recruiting costs related to contract workers are late, these costs go up and the salaries and wages total is lower, and vice-versa.

Automate the Calculation for Some Expense Categories

A number of categories can be pre-populated, as the budget holder will look only at historic numbers and may even misinterpret this data. The finance team is best equipped to provide these numbers as the budgets will be calculated based on historic trend information. The obvious categories to populate and lock down include:

• Communication costs (landlines, Internet, mobile)
• Property costs (power, lighting, property repairs, security, cleaning)
• Consumables
• Fleet costs
• Depreciation
• Miscellaneous costs

Provide Automated Calculations for Travel and Accommodation

When budget holders calculate travel and accommodation costs, they can spend hours searching the web for special deals. They then use these deals for their annual plan. I recommend that you set up a simple calculator. See Exhibit 9.11 with standard costs so all staff have to do is state the date, object of trip, select a return or one-way journey, number of staff, such as “three people going from Houston to Boston for two nights on a roundtrip.”

The model then uses standard estimates to automatically calculate the airfares, accommodation, transfers, overnight allowances and other costs. For example, you might schedule the top 10 routes with standard pricing and have an eleventh flight called “Flights—other” and set a $300 return airfare. Although the forecast won't be exactly right, it is likely to be approximately right because it is based on an average calculated from the last three months of actuals.

Prepare a Simple Reporting Template for the Annual Plan

Annual plans often end up in elaborate reports. The feeling is, “Since we spent so much time on it, we better make a great job of the write-up.” In reality, nobody reads these documents. It is far better to have the documentation left mostly in presentation format along with a key summary page for each business and one for the consolidation. We do not need to report the annual plan to the board in monthly splits. A quarterly analysis of the annual plan will suffice, as shown in Exhibit 9.4.

Have Trend Graphs for Every Category Forecasted

Better quality can be achieved through analysis of the trends. There is no place to hide surplus funding when a budget holder has to explain why the forecast trend is so different from the past trend. The graph shown in Exhibit 9.12, if made available for all the categories budget holders are required to forecast, will increase forecast accuracy. Budget holders will want to ensure their forecasts make sense against the historic trend.

If Using a Spreadsheet, Simplify the Model to Make It More Robust

As explained, forecasting requires a good robust tool, not a spreadsheet built by some innovative accountant that no one can understand now. However, you may not have the time to replace the existing Excel model. A new planning tool will take at least six months for researching, acquiring, and implementing for organizations with over, say, 500 full-time staff. In this case, you can:

• Improve the revenue predictions by focusing in on major customers' demand for the major products. You can automate the rest of the sales based on historic relationships between sales of minor products and major products and sales to minor customers to those made to major customers.
• Budget at category rather than account code level, hiding the rows not required.
• Forecast the annual plan using quarterly figures rather than monthly (hiding two of the monthly columns for each quarter).
• Consolidate via the G/L instead of the spreadsheet (if you can add the category headings easily into the G/L).

Expand Your Team, as Budget Holders Will Need One-to-One Support

Many budget holders will need one-to-one support. Yet, as seen in Exhibit 9.6, we are to do this all in three working days. We thus need to expand the support team. Some suggestions to expand your team are:

• Get all the qualified accountants involved, even those not working in the finance team (e.g., get the CFO involved as well).
• Ask the auditors to loan some audit seniors from their local offices to cover those remote locations—the audit seniors will be happy to be involved in an interesting task (those who have been auditors will know what I mean).
• Bring in some temporary staff with budget experience.
• For smaller budget holders, the senior accounts payable staff would be ideal.
• Offer remote budget holders one-on-one training with Skype-based virtual meeting technologies.

Thus, all budget holders who need help, wherever they are located, can be supported during the three-day window for data entry.

Hold a Briefing Workshop for all Budget Holders

Never issue budget instructions, for you already know they are never read. Follow the lesson of a leading accounting team that always holds a briefing workshop at which attendance is compulsory. With today's technology, you also can hold the workshop simultaneously as a webcast so budget holders in remote locations can attend, albeit electronically. (Attend a webcast to see what I mean.)

Hold a “budget preparation” workshop (see Exhibit 9.13 for an agenda example) covering how to complete the input form and explaining why budget holders do not need to forecast monthly numbers, only quarterly; the three-day window; the daily update to the CEO; and the fact that late returns will be career limiting. Stress that the bigger items should have much more detail. Explain why you have automated some of the categories and the help they will receive, and so forth.

Make sure that at the workshop, the CEO makes the following clear.

• Fast light touch
  • Everybody has to cooperate to achieve the three-day window to enter data.
  • Late forecasting will be a career-limiting activity.
• Help at hand
  • Help will be provided on a one-to-one basis.
  • How to use the planning tool (attendees will already have some training on this).
  • Forecasting by the categories, and why some categories are now automated.
• Level of detail required
  • What they should prepare for their presentation to the budget committee.
  • No monthly breakdown in annual plan, as the monthly numbers are to be set just before each quarter starts.
  • Stress the fact that only the more material categories will have more detail (e.g., payroll).
  • Sales forecast has been already made and is _________.