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Why you must link budgeting and forecasting to planning and performance.

1Feb

No doubt about it, budgeting and forecasting are universally loathed. For the finance department, the process can take six months to complete. For most operations people, it's an overly financial exercise designed mainly to please corporate headquarters. The result, says Holly Snyder, director of planning and management reporting at Nationwide Financial Services (NFS), "is that people don't take ownership of the process."


Part of the problem is that more often than not, budgeting and forecasting are not linked to strategic planning or performance measurement — the other components of what consultants say should be an integrated planning process. Well over half of CFO readers surveyed blame the absence of a well-defined strategy for the lack of value in their planning efforts, and point out that whatever strategy is in place isn't linked to operational plans.


The process is further compromised by its tradition of negotiation and horse-trading. Fully 66 percent of CFO readers surveyed believe their planning process is influenced more by politics than by strategy. Indeed, says Greg Vesey, director of business systems at Texaco Inc., "planning is the most political of all the processes that fall under the finance function."


Making the process more accurate and efficient is no small task. "Reengineering budgeting and planning is the mother of all reengineering projects," says Lawrence B. Serven, a manager at Deloitte & Touche Consulting Group. Throwing time and money at the problem doesn't always help. Neither does a state-of-the-art data mart if the definitions used across functions don't match. Rolling forecasts, balanced scorecards — the hot buttons of today's forecasting gurus — make sense, but only if they're linked to performance evaluation and (the catch) a sincere corporatewide commitment to changing time-worn traditions in finance, sales, and operations. As Serven notes, "the real issues are not process related or systems related; they're people related."



Why Now?

Which explains why many companies are only now getting around to reengineering this process. "The planning and budgeting process is where the transaction process was five years ago," says David Axson, vice president of The Hackett Group Inc., a Hudson, Ohio, reengineering consultancy that recently completed a planning benchmarking study of more than 50 companies. "Everyone is now starting to talk about benchmarking the planning process," he says. "But we're really in the early adoptive stage."


One step toward improving the process is to limit and standardize planning data. According to the Hackett study, the average company currently produces 40 different performance reports, each averaging 24 pages. Yet most include only traditional financial measures. In addition, the average budget contains some 230 line items and eats up an average of 4.5 months of company time.


Another step is to share the information across the company. Today, this information isn't shared on a companywide or a real-time basis. To be effective, it must be communicated across the organization.


A third step is for the entire planning process to be linked to strategic planning and compensation. Here companies are just getting started. In fact, according to the Hackett benchmark, only 58 percent of companies tie compensation to strategic plans and only 19 percent link it to forecasts. Likewise, whatever business planning tools — such as rolling forecasts (see "Sprint Retools the Budget Process," September 1997) and balanced scorecards — are introduced must be linked to performance evaluation and compensation in order to be fully effective.



Reengineerable?

Still, the question remains, "Can business planning really be reengineered?" The answer is yes — to a degree — as long as people are accountable and motivated. But, success in this area will always be fleeting, says Vesey, since "the technologies and the personalities are constantly changing." The result, he believes, is that "reengineering planning has to be revisited every three to four years, without question."


Finance can benefit enormously from leading this reengineering effort. "Finance executives fundamentally understand value creation," says Serven, "whereas many operating managers don't understand how their decisions affect the financials." By sharing that knowledge through the planning process, he says, "finance has a huge opportunity to really elevate its own value."


But finance has to evolve from being a reporter to being a facilitator of the process. "Finance needs to get out of its ivory tower," says Stephen Ibbotson, Avon Products Inc.'s director of global business process redesign, who adds that finance needs to act more like a consultant to operations, marketing, and sales. In the end, says Avon CFO Edwina D. Woodbury, "financial forecasts should be owned by operating management."


The companies profiled here are all currently embroiled in complete overhauls of their business planning systems. None can be thought to have thoroughly reengineered its processes. But while it's premature to claim they embody "best practices,'' they surely are manifesting best efforts — taking the first steps toward turning the planning process into a more meaningful exercise.



Texaco Inc.: Finding Common Ground

Simply launching a reengineering effort in planning is often difficult — especially for companies with multiple geographic or business units — because internal information isn't standardized. "Standardizing data is arguably the most significant best practice a company can have in the planning area," says William Smith, a senior principal with The Hackett Group. Yet according to the Hackett benchmark, only 40 percent of companies have common definitions of products and services and only 32 percent define customers in the same way.


Texaco is out to buck that trend. Three years ago, the oil giant was able to reduce its budget line items from 400 to 180, and now, says director of business systems Vesey, the White Plains, New York-based company is about to embark on another round of reengineering that might lower that number to "the 50-to-75 line-item range." How far can they go? "It depends on your leadership. Our executive committee really uses only about a dozen line items. If you can convince them to stick with that dozen and live without the rigor behind them, you can go that far," he says.


Figuring out how much data is enough, however, is no easy task. "The biggest problem [for any company] is that the business units tend to think corporate asks for more than it really needs," says Vesey. To find a happy medium the first time around, he says, his company relied mostly on E-mail and chat boxes. For the next round, however, the company is assembling a team of three to four dedicated executives and 10 to 12 part-timers to scrub the remaining line items.


To make sure each business and geographic unit is on the same wavelength in the first round, Vesey's group came up with common terminology: "Now if we say 'oil and gas,' " Vesey illustrates, "we'll be talking about the upstream side; for downstream, we'll say 'products and lubricants.' In the future, we'll be asking if you need every expense line, or can you just have one line called 'expenses'?"


The ultimate goal is to tie forecasts more closely to Texaco's strategic and tactical plans. Because the business has unusually long time horizons — sometimes 20 years or more — this has been difficult. "The first year of the strategic plan was never close to the tactical plan," says Vesey. "You could really see a breakage. A current forecast would say x, and when you got to the second year of the strategic plan, you would see a major disconnect. It pointed out assumptions that people were making that were out of touch with reality," notes Vesey. With earnings 8 to 10 years down the pike for capital-intensive projects in new venues like Russia, it was critical to have long-term time frames for strategic planning, but equally critical to be assured that assumptions over that period were solid.


To get at the underlying profitability of each project, Texaco came up with about a half-dozen key business drivers. For example, by looking at expense per barrel, one could ascertain the true payback of a project. "Your absolute expenses might go up, but if you're being efficient on a per-barrel basis, they ought to be flat or go down," explains Vesey. Business drivers could help compare capital budgeting across business units.


Vesey says the next step will be to tie pieces of the drivers, such as safety and lack of loss time, to compensation. "The nonfinancial measures are tougher for us right now," he acknowledges. "It's very easy to make a major price assumption; if there's a major change, everyone knows about it. But the nonfinancial measures — safety, production — we're struggling with."



Nationwide Financial Services: The Right Measures

One way to identify key nonfinancial measures is through the use of a balanced scorecard. And once in place, says Nationwide Financial Services's director of planning and management, Holly Snyder, such a scorecard is a key component of an integrated planning process. Indeed, 46 percent of the companies in the Hackett benchmark are installing balanced scorecards to help link strategy to budgeting and forecasting.


At NFS, a main division of Columbus, Ohio-based Nationwide Insurance Enterprises, the impetus for identifying new planning measures was twofold: In 1996, the company was undergoing two major transitions — the appointment of a new president and the prospect of going public, which it eventually did in March 1997. In addition, NFS, a $58.3 billion (in assets) provider of long-term savings and retirement products, was also facing not only stiff competition from the financial services industry, but also a customer base that was demanding individualized financial solutions.


"Before we went public, 75 to 80 percent of the data we used for planning was financially focused — traditional bottom-line measures," says Snyder, who leads the reengineering team, which is also working on a six-quarter rolling forecast and an overhaul of its compensation plan in an effort that could take up to two and a half years.


After some extensive benchmarking, Nationwide executives realized that the company's traditional performance measurements were inadequate for its changing environment. "We really had no linkage to nonfinancial attributes — customer satisfaction, employee satisfaction. We'd been taking a lagging, more financial approach," says Snyder.


Moving from a static to a much more dynamic process meant measuring performance with a balanced scorecard. And determining the appropriate measures required the involvement of all functional areas of NFS, not just the actuaries who had traditionally been the forecasters. "We needed a dedicated project team to reengineer planning and to implement a balanced scorecard," says Snyder. To that end, NFS tapped 20 managers, 10 who were dedicated systems people and another 10 who maintained their department disciplines in sales, marketing, and operations, but devoted 50 to 75 percent of their time to the project. "If we had done this just within finance itself," says Mark R. Thresher, NFS's treasurer and vice president of finance, "it wouldn't have worked." Because of the nature of the information needed, "we didn't want to pigeonhole the scorecard into simply becoming a financial tool," he adds.


Together, the team has developed a scorecard of 16 measures, which it is trying to whittle down to 14. Included on the list are traditional financial measures, such as net operating income and return on equity, as well as new nonfinancial measures of customer retention, customer service, and back-office productivity — measures Robert A. Oakley, CFO and executive vice president of Nationwide Insurance Enterprises, says "often give better and faster insight into what's happening and where your business is going." In addition, the team has identified the critical success factors for each of the scorecard goals as well as the drivers behind them.


While the scorecard is still in the manual stage, it will become a key measure of performance within the planning process. At NFS, says Snyder, business planning encompasses "strategic planning, tactical and financial planning, forecasting, and scorecard reporting." It's the last step, she says, that "gives us a mechanism for continuous feedback." The scorecard is inextricably linked to the budgeting and forecasting process, since improving any measure typically involves an allocation of resources. In addition, the goals and targets for the scorecard are a major component of overall planning. Suppose, she says, "we set a goal for premium growth — one of the measures on the scorecard — at 27 percent, but our six-quarter rolling forecast says that on an ongoing basis we can expect only 23 percent." The scorecard, she explains, "helps us figure out how we are going to achieve that 4 percent gap. Maybe we hire more wholesalers; maybe we change our brand image. Whatever it is, the scorecard model is the tool we use to outline necessary changes."


To ensure companywide acceptance, the team has worked diligently toward consensus outside the finance function. "We used a very iterative process to come up with what everybody thought the measures should be," says Snyder. "The team in and of itself did not own the measures. There were many sessions with groups from marketing, finance, and operations. We had literally hundreds of people for validation," adds Snyder. And so far, Thresher doesn't believe the scorecard has been a tough sell, since "people clearly like the idea of starting with top-down targets."


To date, NFS has completed its paper balanced scorecard and is working on automating the process by the end of the year. Eventually, the scorecard will be rolled out to the other businesses within Nationwide Insurance Enterprises. "We plan to cascade the nonfinancial parameters very deeply into the organization, possibly down to the absolute lowest levels," says Oakley. "If we can make every employee understand how their success contributes to the overall success of the organization, then the system will be complete."



Avon Products Inc.: Sharing Information

Having the right measures and standardizing data are steps that go a long way toward improving the planning process. But at many companies, the problem is that the information isn't shared. In fact, according to the Hackett study, only 24 percent of companies have a single planning and reporting system, and only 35 percent of executives have online access to the information.


At Avon Products, however, the goal is to have real-time access to planning information available companywide by the end of this year. And already the New York-based beauty-products company is in the midst of rolling out a data mart system from its United Kingdom operations that it hopes will help the rest of the organization add more value to planning.


"We have data marts in the UK for marketing, finance, and sales data online. And they're being used for operational management, not just executive decision making," says Stephen Ibbotson, Avon's director of global business process redesign. For example, data marts allow sales managers to instantly track online how much product has been sold instead of having to manually extract data from source systems. "It's helping us redefine our business processes and making sure we're compatible. It's also helping the functional areas change the way they work."


Avon chose to go the data mart route over a data warehouse redesign (see "Going Down to the Data Mart," December 1997) because, Ibbotson says, "it was a cheaper and more effective route to go." For our purposes, he says, a data warehouse would be overkill — "like using a sledgehammer to crack nuts." Just deciding which software to use, though, took up 9 months of the 18-month project. In the end, the company chose Oracle data marts and Cognos decision-support software.


The data marts, however, are only the first step in Avon's complete overhaul of its budgeting and planning process — a process that currently involves about 150 people worldwide. They produce forecasts for more than 40 international operating units with more than 6,000 products. One of the goals of the reengineering will be to integrate all of their projections. "We have a considerable amount of project and forecasting skills in our sales and marketing organization," says Ibbotson. "But we don't leverage that through an integrated forecasting and planning system. Finance will come up with a forecast, and they don't see marketing and sales people. We need to make sure we have a coordinated forecast."


That coordinated forecast also has to be globally focused, says Ibbotson. "The thing that is potentially going to be our biggest inhibitor is [ensuring consistency] across geographies," he says. "Our current business is geographical; each business unit reports to a regional head. It needs to be a global process reflecting the global nature of manufacturing and procurement."


In the end, of course, the goal is to link the integrated forecasts with strategic and tactical planning. "Our current process is inefficient," says CFO Edwina Woodbury. "We have to crunch a lot of numbers to come up with a forecast or a plan."


Instead, "we need to involve the whole business with strategic and tactical planning," says Ibbotson, who points out that the overall reengineering project will eventually include other processes, such as supply chain and order management. "And consistent data will make the whole process quicker and cheaper."



Cathy Lazere is a freelance writer specializing in corporate finance.



Planning Patterns: What the Stats Reveal


Like an aching tooth, there's no escaping the business planning process for most finance executives. Typically, beginning around July, the planning process requires finance to assemble all the various forecasts throughout an organization, separate fact from fiction, and disseminate the results in a usable action plan — all by the end of the year.


To find out just how painful the process is, CFO recently surveyed 500 readers about their attitudes toward business planning and their current efforts to improve it. Designed by Lawrence B. Serven, a manager with Deloitte & Touche Consulting Group, the survey found that while approaches to budgeting and forecasting may differ, most respondents are dissatisfied with their current processes and believe there is plenty of room for improvement.


The level of dissatisfaction is overwhelming. While, on average, five full-time finance employees and eight nonfinance FTEs spend three (83 percent) to six (15 percent) months on business planning, 90 percent of respondents believe their current process is somewhat cumbersome. And only 45 percent think that most people are completely satisfied with the planning process.


The discontent is both big-picture oriented and individually driven. "The main reasons people feel planning doesn't offer value is (a) they lack a well-defined strategy and (b) there's no connection between planning and strategy," says Serven, whose book Planning to Win: How to Drive Shareholder Value Every Day will be published in the spring by John Wiley & Sons. "If you think rolling forecasts are your silver bullet, or you're installing Hyperion software, or you're using activity-based costing, that's fine. But how are you addressing the fact that strategy is not linked to operational planning?"


That disconnect, he says, is compounded by the fact that there's little individual accountability for results. In fact, only 55 percent of respondents say that strategic goals cascade down into individual objectives, and less than 50 percent say that performance targets are clearly linked to senior- and mid-manager pay. "If you don't give people economic incentives to achieve a plan, it's not worth the paper it's printed on," says Serven.


Where these problems manifest themselves is in the results. "Only a very small percentage of respondents (12 percent) say their planning process is completely reliable," Serven points out. The implication, he says, is that for most companies, "planning is still more a process of gazing into a crystal ball and trying to forecast events than establishing a set of commitments and sticking to them."


What's most frustrating for financial executives, however, is that they know what their role should be in the planning process, but they are being thwarted in their efforts. Revealingly, although survey respondents recognized that partnering with other departments to add value to their business was "very important" (scoring 3.9 out of a possible 5.0), they graded their performance in this area as merely "moderate" (scoring a 3.5 out of a possible 5.0).


One solution, says Serven, is to make sure that planning gets the senior-level finance attention that it demands. "In many companies, planning is viewed as a process, as opposed to a management system, and is handed over to a lower-level executive. Only when it's embraced as a management system that yields results, and only when the CFO is the one driving the outcome, will finance be able to fully partner in the process," he says.



Lessons from the Front


The Avon, Texaco, and Nationwide cases provide some vital lessons for companies in the midst of overhauling budgeting and forecasting.



  • Keep the team involved. Make sure the team cuts across divisions and functions. Members should be kept posted on time commitments and schedules. "The secret is to involve everybody in the definitions. We didn't want a short cut. It's going to succeed if it's reasonably paced and involves as many people as possible in the front end," says Holly Snyder, Nationwide Financial Services's director of planning and management reporting.

  • Limit data requests to what's necessary to fulfill strategic objectives. "When you get right down to it," says Texaco's director of business systems, Greg Vesey, "what we talk about with our line executives is maybe a dozen line items."

  • Don't expect technology to give you a quick fix and to resolve everything. If the data is ill-defined or if there is too much data, the planning process will suffer.

  • Link forecasting to activity-based management. Clear definitions of processes and cost drivers should accompany projections of future sales. Make sure you look at the expense side of sales and operations; otherwise, your projections will be useless.

  • Don't be seduced by trendy procedures, such as rolling forecasts. While a sneak preview of future quarters can be valuable, companies must ask if the information contained in such forecasts is worth the time and effort.

  • Be a business partner, not just a reporter. Finance needs to be in touch with the business processes, not just passively recording results.

  • Get senior-level nonfinancial sponsorship, preferably from the CEO. Otherwise, the process is in danger of remaining simply a financial exercise. —C.L.




Balancing the Balanced Scorecard


For a company setting up a balanced scorecard, a critical factor is choosing the right metrics that reflect competitive factors affecting the business. Choosing the right metrics, however, means also choosing the right number of measurements.


"The challenge in implementing a new system is a bandwidth issue," says Robert Hershey, partner in charge of KPMG Peat Marwick's World-Class Finance Practice. "How much data can your organization absorb at one time?" Hershey recommends no more than 20 key indicators in four distinct areas:





  • Five Financial Indicators. These include traditional financial measures like profit, growth, and ROE — the macro measures that companies need to achieve success.

  • Five Customer-Related Indicators. These answer the question: How do customers view the organization? Measures include customer retention and customer satisfaction.

  • Five Process-Related Indicators. These relate to production and operating statistics on how well the customer is being served by the organization. Examples include order-rate fulfillment and cost per process or order.

  • Five Future-Value Indicators. These examine how capital — including human capital — is being managed for the company's future growth. How well are new products introduced? Are top people being retained? Are processes being improved? —C.L.

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