David Parmenter is an international presenter, writer and facilitator on developing winning KPIs, replacing the annual planning process with quarterly rolling planning (QRP), quick month end processes, and converting reporting to a decision based tool. In this two part series, he explains how to implement QRP successfully.
The only certainty about an annual target is that it is wrong. It will be either too soft or too hard for the trading conditions.
There are four main problems. Budget holders are encouraged to be dysfunctional, the reporting is based around irrelevant monthly targets, management is taken away from making money for a three month period, and the remuneration system is based on an annual target. QRP removes these barriers.
Monthly budgets: flawed logic
As accountants we never need to break the annual plan down into 12 monthly breaks before the year has started. A sporting analogy (figure one) explains the folly of the monthly budget.
If the annual plan is the establishment of goal posts at the end of the pitch, the budget process is setting 12 x 10m lines to report against. Yet the 10m lines (the monthly budgets) are wrong as soon as the year has started.
Figure one: annual plan analogy
Quarterly rolling forecast
The critical building block for QRP is the quarterly rolling forecast (QRF). Although many organisations use forecasts to monitor performance, they begin with flaws:
- due to poor tools and expediency, the forecaster (budget holder or analyst in finance) uses the budgets of the remaining months as a guide to future expenditure
- as it would be a nightmare to use the budget Excel models, forecasts do not involve the budget holders
- the forecasts are updated monthly (an unnecessary timeframe)
- forecasts (and therefore management focus) only go up to the year’s end, even though the new business year may be starting in the near future.
The QRP process
In the quarterly forecasting process management sets out the required expenditure for the next 18 months (see figure two). Each quarter, before approving these estimates, management sees the bigger picture six quarters out. All subsequent forecasts update the annual forecast while firming up the short term numbers for the next three months.
Budget holders are encouraged to spend half their time getting the detail of the next three months right, and the rest of the time on the next five quarters. No quarterly forecast is ever a completely new start, as it will have already been reviewed a number of times.
The overall time of the four forecasts is as little as five weeks, whereas an average annual planning cycle takes 8-12 weeks.
Figure two: how the rolling forecast works
QRF versus QRP
QRF gives management a better picture of the future by reporting against the forecast and the budget. However it does not tackle the main issue ‒ the annual planning process and the monthly budget.
Organisations who have gone the extra mile and thrown out the annual planning process entirely have converted their QRF to a QRP process, ensuring:
- an adaptive performance management structure
- management looks forward on a regular basis
- the monthly budget is replaced with a more up to date monthly target
- monthly reporting improves radically, as you now report against a meaningful target.
Involve all budget holders
Most forecasting models, built in Excel, tend to be a top-top approach, where consultation is restricted to people removed from the workforce. A proper rolling forecasting regime should involve a bottom up process consistent between different functions, with production based on forecast demand rather than the other way around.
Involving all budget holders ensures buy in to the numbers, a forecast that more closely resembles reality, and a positive learning curve as budget holders get better at a repetitive task.
Never forecast at account code level
As accountants we never needed to set targets at account code level. We simply did it because we did last year, without thinking as well.
Do you need a target or budget at account code level if you have good trend analysis captured in the reporting tool? Probably not. You should apply Pareto’s 80/20 rule and establish a category heading that includes a number of general ledger (G/L) codes.
Rules that can be used include:
- limit the categories that budget holders need to forecast to 12
- select the categories that can be automated, and provide these numbers
- separate out a forecasting line if the category is over 20% of total (eg, show revenue line if revenue category is over 20% of total). If the category is between 10% and 20% look at it and make an assessment if separate disclosure is required. If under 10% consolidate with other categories
- allow the budget holders to have some flexibility in the categories to best reflect their operation. Planning tools can easily cope with this complexity by the mapping of G/L codes to categories (try doing this in an Excel spreadsheet! If you can you should work for NASA)
- accurate forecasting of personnel costs requires analysis of all current staff (their end date if known, salary, likely salary review and/or bonus), and all new staff (their starting salary and likely start date).
Read part two in September's edition of Insight.
Links
20 major mistakes made by accountants - and how to avoid them
Implementing winning KPIs
Quick month end reporting