Strategy: is forecasting destroying your planning process? Part 126.96.36.1998
Imagine the coaching staff of an American football team “forecasting” the number of wins the team will have in a season. Have you ever heard a coach say, “We’re projecting seven wins and nine losses for the upcoming season”? No, and for good reason: Coaches are paid to win games, not forecast them.
Now imagine the same coaches updating their forecast based on actual win-loss results during the season, conducting weekly variance analyses to see if their projection was accurate and what assumptions they made that turned out to be wrong: “We would have won, but number 47 on offense had only 40 yards rushing while we forecasted he’d have 70.” If you were a fan of the team, you’d start to wonder why the coaches didn’t instead spend that time developing a playbook and practicing you know, the stuff that wins games. Yet this happens in businesses every day when forecasting overshadows or even replaces business planning. Part of the problem is that the terms are often used interchangeably.
But they are different. Planning is about knowing where you are today, determining where you want to go, and building a plan of action to get there. It fits the very definition of being proactive. Forecasting, on the other hand, is a crystal ball exercise. It’s about estimating what the future might bring. This isn’t to disparage forecasting. Both have their place and add value. Yet while many companies say they do planning, if you followed them around as they went through their processes, you’d have to conclude they’re actually doing very little planning and a lot of forecasting.
Planning or forecasting?
Take a look at the most common “planning” process the development of the annual plan. It goes by many names, such as the annual operating plan (AOP), the budget, or simply “the plan,” and usually involves a look at the anticipated balance of year results and the full 12 months of the following year. In the typical process, the CEO and senior executives establish a financial target. This target almost certainly involves revenue but often targets for profit or EBITA (earnings before interest, taxes, and amortization) as well. Depending on the size of the company, targets will also be set for business units, geographies, product lines, and so forth. Financial analysts have spreadsheet models that will take assumptions and translate them into financial projections. These models can be used to “back into” a number in other words, users can keep adjusting the assumptions in the model just to get the desired answer. The simplest example of this is a revenue model built on assumptions for units sold and price. The analyst adjusts either input, or both, to produce a revenue projection. If the corporate management team has handed down a revenue target of 5% growth, the analyst can keep adjusting the price and unit assumptions to get there. Easy enough.
Of course, the Sales and Marketing departments might not want to sign up for a 5% growth target, so they’ll work with Finance to adjust price and volume assumptions to get to a number they feel more comfortable with, such as 3% revenue growth. If they’re smart, they’ll build some rationale along the way, for example, by arguing that increased price competition lowers the ability to raise prices or that stagnant market growth calls for capping volume assumptions.
The example here is a simple one focused on one line in the profit and loss (P&L) statement and using just a couple of input variables. You know these models get much more complicated. For each line in the income statement, there’s a model with its own set of inputs and calculations. Travel, salaries, advertising and promotion, trade discounts, overtime, raw materials, and more all have to be addressed.
In many companies, this is the typical annual planning process. Management hands down targets, Finance runs financial models to see what assumptions are needed to achieve them, and operational managers negotiate lower expectations to update those models.
What does any of this have to do with actually running a business? Nothing. And that’s exactly what frustrates people about the process and why nonfinance managers see so little value in the “planning” process.
It’s also the reason why flavor-of-themonth approaches to “better planning” never seem to pan out. They focus on how frequently forecasts are produced, or at what level of detail, or whether “budgeting” is needed at all. But they don’t get to the heart of the matter, which is that forecasting has all but replaced planning. And forecasting, though important, is not a substitute for business planning.
10 QUICK TIPS TO TRANSFORMING YOUR ANNUAL PLAN
Create a short-form P&L. Aim for no more than five lines. This will be easy to work with yet provide enough detail to establish the "sidelines and goalposts."
Establish targets for the short-form P&L. These targets should be well informed based on knowledge and expertise of senior management and further informed by trend analysis and unbiased projections provided by Finance.
Identify initiatives to achieve the targets. Initiatives are high-level projects that define how to achieve the targets established by senior management. They should include at least a high-level estimate of the resource requirements.
Review and approve Initiatives. Not all initiatives are equal, and each needs to be evaluated on its ability to drive the desired business results.
Develop execution plans that include activities and tasks. Approved initiatives need to be broken down into actionable activities and tasks in order to be executed.
Draft detailed budgets for the initiatives. With the approved initiatives in hand and supported by detailed execution plans, the organization is ready to develop an overall budget.
Create a full-length P&L. Expand the short-form P&L into a full version that incorporates the new budget.
Review and approve the annual plan. Now that all the pieces have been made tougher and a full P&L produced, senior management has an opportunity to provide its input and final approval.
Create tracking mechanisms to report on the progress of the execution plans.
Though easy to overlook, this step is a vital part of the approach to business planning. It provides the mechanism to track the progress of execution plans right alongside the financial results. Monitor ongoing progress and make course adjustments as necessary. Life doesn't always go the way we want it to, nor does business. Tracking ongoing progress gives the organization an opportunity to adjust plans to get back on track and achieve what it set out to do.
True business planning
While forecasting focuses on “what if,” business planning focuses on “how to.” While what-if questions are always interesting, an organization’s success ultimately is driven by how effectively it can answer the how to question.
5 DO'S AND DON'TS FOR PLANNING
|Think Iike a business owner||Don't limit your perspective to accounting|
|Work with executives to establish well-formed, appropriate targets||Don't just adjust model inputs to meet an arbitrary goal|
|Focus on how business goals will be achieved||Don't just churn budget assumptions|
|Get out into the business||Don't spend your time maintaining spreadsheets|
|Foster active communication throughout the process||Don't relegate communication to budget templates|
Consider a hypothetical example where XYZ Company has a revenue growth goal of 8%. Rather than debating whether it instead should be 7% or 6%, the company would be much better off focusing on how the 8% goal will be achieved.
When talking about how an organization will achieve a goal like an 8% growth target, it isn’t about looking for superficial answers. For too many organizations, a conclusion such as “We’ll launch a new marketing program” seems to suffice. In the best-run companies, however, the planning discussions dive deeper. They’ll cover the components of that new marketing program, the timetable for rolling out each component, who the key employees are and their responsibilities in delivering the plan, and the type of resources required. The point is that the business planning conversation focuses on how the goal will be met, with senior executives challenging assumptions and testing the thinking behind the plan. If the process is done well, the result is a well-honed plan of action to drive success.
Going back to the football analogy, too many companies get caught up in the process of debating if their projected win-loss ratio should be 7–9 or lowered to 5–11. What they should do is identify what they need to do to win and then develop a playbook to do it.
And here’s an interesting point: If the organization puts real thought and effort into how the goal will be achieved, then even a subsequent discussion about whether the target should be changed will be that much better informed and productive. Why? Because at that point senior management is evaluating a real action plan, and the conversation will center on what can be expected by executing those plans successfully. That’s why it’s important to develop well-informed, high-level targets and direct the organization to develop plans to meet them rather than spending that time debating targets.
In the next part we will continue with themes: Improve variance analysis, traditional of forecasting and more..
is a globally recognized authority on enterprise performance management (EPM). He began his career as FP&A manager at Pepsi Cola International and went on to found one of the fastest-growing EPM software companies in North America. Lawrence is the author of Value Planning: The New Approach to Building Value Every Day (J. Wiley & Sons) and is coauthor of IMA’s global survey and research project on FP&A. He can be reached at email@example.com.