By David Parmenter

Extract from my toolkit which is on sale (over 40% discount) An Annual Plan in Two Weeks or Less Toolkit (Whitepaper + e-templates). You can look inside the toolkit

In earlier articles, I have argued, quite strongly, that the annual planning process is part of the trifecta of lost opportunities for a corporate accountant. The future is the total abandonment of the annual process as it should be replaced by a rolling quarterly, 6 quarters outlook.

But, we first need to move the data gathering and approval process in the annual plan into a two-week timeframe.  To avoid confusion, I set out steps as those that are important(I called them milestones). The less important steps are called features.

The ten foundation stones

There are ten foundation stones that need to be laid before we can commence a project on reducing the annual plan to two weeks.

  1. Separation of targets from the annual plan
  2. Bolt down your strategy beforehand
  3. Avoid monthly phasing of the annual plan
  4. The annual plan does not give an annual entitlement to spend
  5. The budget committee commit to a “lock-up”
  6. Budget at category level rather than account code level
  7. Get it wrong quicker-2 weeks for preparation and two weeks for final numbers
  8. Model built in a planning tool—not in a series of Excel workbooks
  9. Plan with periods that are either 4 or 5 weeks long
  10. Annual planning team’s two-week preparation

1. 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% growth in net profit, yet management may see that only 10% is achievable with existing capacity constraints.

The key is to remove any deliberate manipulation related to performance bonuses.  In a working guide on ‘Designing 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.

Exhibit 1 shows where management has forced the plan prepared in March to meet the target set by the Board. Each subsequent re-forecast continues the charade until in the final quarter re-forecast, performed in March of the following year, the truth is revealed.

Exhibit 1: Reporting what the Board want to hear

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2. Bolt Down Your Strategy Beforehand

Leading organizations always have a strategic workshop out of town.  Normally, Board members will be involved as their strategic vision is a valuable asset.  These retreats are often run by an experienced external facilitator.  The key strategic assumptions are thus set before the annual planning round starts, also the Board 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 on strategy and the dreaded annual planning process.

3. Avoid Monthly Phasing the Annual Budget

As accountants, we thought it 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 November’s budget was close to February’s actuals.  In other words, whilst the twelve columns may add up to a year, that proves 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 2.6 for a suggested one-page summary format.

The monthly targets should be set a quarter ahead using a quarterly rolling forecasting process. This change has a major impact on reporting. We will no longer 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, you will make management, all around the organization, write variance analysis 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.

4. 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. Asking budget holders ‘What they want’, making it clear if it is not in the budget you cannot spend it and then, after many revisions giving them an “annual entitlement” is the worst form of management we have ever presided over.

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 that when a budget holder is funded only three months ahead, the funding estimates are much more precise, and there is little or nowhere to hide those slush funds.

5. 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 modern thinking CEO 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 non-financial 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 _____)

6. Budgeting at Category Level Rather Than Account Code Level

It is far better to budget at the category level rather ( a collection of account codes) than at the 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 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.

[i] Carveth Read, Logic, Deductive and Inductive (1898).

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 the 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.

Helpful rules for setting up cost categories include:

  • Budget for an account code if the account code is over 10 per cent of total expenditure. If the account code is under 10 per cent, amalgamate it with others until you get it over 10 per cent. See Exhibit 2.1 for an example.
  • Limit the categories that budget holders need to forecast to no more than 10.
  • 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.

Exhibit 2: How Forecasting Model Consolidates Account Codes

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7.    Getting It Wrong Quicker

The only thing certain about an annual plan is that it is certainly wrong as it cannot simulate 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.

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 non-negotiable 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.

8. Model built in a Planning Tool –Not in a Series of Workbooks

Spreadsheets have no place in forecasting, budgeting, and many other core financial routines. Spreadsheets were not designed for many of the tasks they are currently used to accomplish. In fact, at workshops, I often remark in jest that many people, if they worked at NASA, would try to use Microsoft Excel for the US space program, and many would believe that it would be appropriate to do so.

A spreadsheet is a great tool for creating static graphs for a report or designing and testing a reporting template. It is not, and never should have been, a building block for your company’s finance systems. Two accounting firms have pointed out that there is approximately a 90 per cent chance of a logic error for every 150 rows in an Excel workbook.[i]

[i] Coopers and Lybrand found 90 per cent of all spreadsheets composed of more than 150 rows contained errors (Journal of Accountancy, “How to Make Spreadsheets Error-Proof”) and KPMG found 91 per cent of 22 spreadsheets taken from an industry sample contained errors (KPMG Management Consulting, “Supporting the Decision Maker: A Guide to the Value of Business Modelling”).

9. Plan with Periods 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 the calendar or working days.

Simply design the model so that smoothing back to the regular calendar can be removed easily when you decide 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?”

10. Annual Planning Team’s Two-week Preparation

In my days with BP Oil, we would spend 6 to 8 weeks in the planning preparation. The most time-consuming part was rewriting the budget instructions, which, to my shock, nobody read.

In these two weeks, the planning team would:

  • Review last year’s process and seek to make more efficiencies
  • Prepopulate the model with the automated cost categories (discussed earlier) and the current salaries for each team.
  • Prepare and present the budget workshop (the CEO making it compulsory attendance for all budget holders)

For more details on these foundation stones purchase my toolkit.

Efficient annual planning procedures

In addition to the 10 foundation stones, you will need to adopt these efficient annual planning procedures these include

  1. Hold a Focus Group Workshop to Get the Go Ahead
  2. Forecasting Demand by Major Customers by Major Products
  3. Preparation Work: On the Annual budgeting Model
  4. Accurate Budgeting of Personnel Costs
  5. Automate the Calculation for Some Expense Categories
  6. Provide Automated Calculations for Travel and Accommodation
  7. Prepare a Simple Reporting Template for The Annual Plan
  8. Have Trend Graphs for Every Category Forecasted
  9. If Using Excel Simplify the Model to Make It Robust
  10. Expand Your Team, as Budget Holders Will Need One-to-One Support
  11. Hold a Briefing Workshop for all Budget Holders

For more details on these procedures purchase my toolkit.

Next steps

  1. For more information on these foundation stones and procedures include E-templates, buy my toolkit which is on sale (over 40% discount) An Annual Plan in Two Weeks or Less Toolkit (Whitepaper + e-templates). You can look inside the toolkit
  2. View this YouTube  Beyond Budgeting – an agile management model for new business and people – Bjarte Bogsne, at USI
  3. Read:

https://review.firstround.com/Annual-Planning-is-Killing-Your-Growth-Try-This-Instead

https://hbr.org/2006/01/stop-making-plans-start-making-decisions

https://corporatefinanceinstitute.com/resources/knowledge/finance/beyond-budgeting/