The 8 myths around annual planning
By David Parmenter
There are many reasons why your annual planning in your organization is not working. One main factor is a lack of understanding of the myths surrounding annual planning.
Just like six centuries ago we are blind to the realities that are there to see on closer observation. We have for centuries blindly applied old thinking to how we measure, monitor and improve performance.
Myth 1: There is a need to set annual targets
It is a myth that we know what good performance will look like before the year starts and, thus, it is a myth that we can set relevant annual targets. In reality, as former CEO of General Electric, Jack Welch[i] says, “it leads to constraining initiative, stifling creative thought processes and promotes mediocrity rather than giant leaps in performance”. All forms of annual target are doomed to failure. Far too often management spend months arguing about what is a realistic target, when the only sure thing is that it will be wrong. It will be either too soft or too hard.
I am a follower of Jeremy Hope’s work. He and his co-author Robin Fraser were the first writers to clearly articulate that a fixed annual performance contract was doomed to fail. Far too frequently organizations end up paying incentives to management when, in fact, they have lost market share. In other words, rising sales did not keep up with the growth rate in the marketplace. As Hope and Fraser point out, not setting an annual target beforehand is not a problem as long as staff members are given regular updates about how they are progressing against their peers and the rest of the market. Hope argues that if you do not know how hard you have to work to get a maximum bonus, you will work as hard as you can.
Just like a high jumper in the Olympics to win they must jump the highest. Having a predetermined height set in their minds will only limit their performance.
Myth 2: We could set meaningful monthly targets from the annual plan
As accountants, we like things to balance and our work to be neat and tidy. Thus, it appeared logical to break the annual plan down into twelve monthly breaks before the year had started. We could have been more flexible. Instead, we created a reporting yardstick that undermined our value to the organisation. Every month we make management, all around the organisation, write variance analysis which I could do just as well from my office in New Zealand. “It is a timing difference” “We were not expecting this to happen”, “The market conditions have changed radically since the plan” etc.
Myth 3: We only need to forecast out to the current year-end
Typically, corporate accountants reforecast only to year-end. Two months before year-end management appear to ignore the oncoming year. Better practice is to forecast for a rolling period that passes through the year-end barrier.
Myth 4: Giving budget holders an annual entitlement made sense
Doing an annual plan is daft enough but to compound it with eventually giving a budget holder the right to spend an annual sum is the worse form of management accountants have ever presided over.
By forcing budget holders to second – guess their needs in this inflexible regime, you enforce a defensive behaviour, a stockpiling mentality. In other words, you guarantee dysfunctional behaviour from day 1.
Myth 5: We need to budget at account code level
What made accountants ever conceive that we needed to set targets at account code level? It was done by our forefathers, so we duly followed in the well-trodden steps. It makes no sense.
Having budgets at account code level has encouraged budget holders to allocate expenditure to an account that that has room for it, thus at a single stroke undermining the purpose of the G/L which is to account for costs and revenue in the right areas.
The annual planning process is not adding value, instead it is undermining an efficient allocation of resources, encouraging dysfunctional budget holder behaviour, negating the value of monthly variance reporting and consuming huge amounts of time from the Board, senior management team, budget holders, their assistants and of course the finance team.
When was the last time you were thanked for the annual planning process? At best, you have a situation where budget holders have been antagonized, at worst, budget holders who now flatly refuse to co-operate!
Like a laboratory rat we go down the same pathway each year to find there is no cheese, no passing ‘Go’ and no collecting £200 (a Monopoly reference), just mayhem. The annual planning process may have worked for Julius Caesar but certainly not for us.
The nightmare of three to four months arguing over resource allocation when nobody knows the answer, the endless cut-back rounds, and the game playing, the spend–it or lose-it-mentality is not befitting the 21st century.
Myth 7: We had to use Julius Caesar’s calendar
Julius Caesar gave us the calendar we use today. It is not a good business tool because it has divided up the year in uneven periods. With the weekdays and number of weekend days, in any given month, being different to the next month it is no wonder forecasting and reporting is unnecessarily compromised.
Even if we are stuck, in the short term with reporting results on calendar months we can and should base our forecasting models around a 4,4,5 quarter e.g., there are two four-week months and one five-week month in a quarter. The model would them smooth back the numbers to the correct working days for monthly targets.
Myth 8: The annual planning process will be quicker this year
Each year I was involved in the annual planning process I thought I had discovered the secret to cut months out of the process. I even had budget holders on my side saying, “Yes we agree that four months is ridiculous, and we will cooperate.” As you all know the next annual plan will be as worse as the last one because once the annual planning process has begun budget holders commence their political gesturing. It is just like Pavlov and his dogs.
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