1. business and industrial

Transforming financial planning
in small and medium sized companies
Dr. Peter Bunce, BBRT Director
Abstract:: At the core of performance management is the planning and budgeting
process. For most companies plans and budgets are negotiated, annual and fixed.
Nothing is more likely to stifle adaptive and innovative management that this rigid,
sterile process. That’s why companies need to move to a more continuous, rolling
process and abandon annual planning and budgeting. This paper examines these
issues, how small and medium sized companies that are still adaptive, responsive
and innovative can avoid the sclerosis of many larger companies and how managers
can implement a more continuous approach to planning.
Dr Peter Bunce
BBRT
745 Ampress Park
Lymington, Hampshire SO41 8LW, UK
Tel: +44 1590 679803
Fax: +44 870 705 8799
Email: [email protected]
Web site: www.bbrt.org
Contents
1. Introduction............................................................................................................................3
2. The issues for small and medium sized enterprises (SMEs)..................................................3
3. Manage through continuous planning cycles.........................................................................4
4. The dangers of the fixed performance contract .....................................................................5
5. Make rolling forecasts the primary management tool ...........................................................7
5.1. Rolling forecasts in action ..............................................................................................7
5.2. Forecasting accuracy.....................................................................................................10
5.3. Making forecasts a management not a measurement process ......................................10
6. Managing costs through trends ............................................................................................11
7. Making it work.....................................................................................................................12
8. Acknowledgments................................................................................................................14
References................................................................................................................................14
1. Introduction
How do you plan today? Do you spend several weeks or even months each year
preparing a financial plan or budget for the following 12 months? Does this plan of budget
include the targets you are required to meet at year end and are these targets and the budget
linked to the incentives scheme? Do you also find that this plan is out of date only a few
weeks after approval requiring frequent re-planning and re-budgeting during the year? If so,
you are following the pattern of most companies.
Most performance management systems involve plans, targets and resources that are
negotiated, annual and fixed. These systems were designed for stable trading environments
where demand exceeded supply and suppliers could thus dictate to the market. Times have
changed and now competition has increased, markets have become much more unstable and
customers rule. While many leaders talk about adapting to change, few know how to change
their systems so that it becomes a natural response to the environment. Instead ingrained
belief in rationality and ‘predict and control’ causes them to spend huge amounts of energy,
time and money trying to align and re-align the strategies, structures and systems to meet a
changing business climate. This inability to cope with discontinuous change is caused by
hard-wired ‘plan-make-and-sell’ business models and management systems. In contrast many
leading-edge organizations are undergoing an historic shift from ‘make-and-sell’ to ‘senseand-respond’ management. Make-and-sell is an industrial-age model centred on transactions,
capital assets, mass production, economies of scale and product margins. Sense-and-respond
is an innovation and service-age model that emphasizes client relationships, intellectual
assets, mass-customization, and economies of scope and value creation (Haeckel, 1999).
2. The issues for small and medium sized enterprises (SMEs)
New companies start out by being highly responsive and in tune with their markets –
they are very much ‘sense-and-respond’. True, the founder often starts out by making all the
key decisions, but the management team is usually composed a small, dedicated and highly
motivated group of people. As the company grows the teams get bigger, the chain of
command gets increasingly stretched, and the flexibility and adaptability diminishes. As most
start-up companies grow and mature the founder often still wants to retain some degree of
control so they take on board the ‘command and control’ management model they see
operating in larger companies.
The command and control model emerged in the early 1990s to help companies meet
rising demand and maximize profitability. With its main focus on efficiency, it introduced
division of labour, incentives linking pay to performance, functional organization and
centralized decision-making. The annual planning and budgeting process that ties it all
together is its defining characteristic and the source of many of its problems today.
Most senior executives want their organizations to be more responsive and more
adaptable, but few know how to turn management rhetoric into operating reality. They talk
about fast response, empowerment, innovation, operational excellence, customer focus and
shareholder value, their management processes remain stuck in the past. The traditional
command and control management model with its annual planning and budgeting process
stifles innovation, entrenched functions undermine cross-functional processes, an emphasis
on product targets works against customer intimacy and short-term performance contracts fail
to support long-term value creation. The millions spent each year on new tools and
techniques such as re-engineering, customer relationship management, team building,
Transforming financial planning in SMEs
June 2007
© BBRT 2007 – All rights reserved
Page 3 of 14
enterprise resource planning systems, value-based management and balanced scorecards do
not seem to overcome these problems. They support the rhetoric but flounder when faced
with the forces of centralised decision-making, fixed performance contracts and the immune
system of the traditional planning and budgeting system.
If SMEs follow this path already well trodden by larger companies they will end up in
the same position of having a management model that fails to support innovation, flexibility
and adaptability. SMEs need to retain their innovative approach, speed and adaptability as
they grow in size. They need to adopt a management model that supports the company’s
success factors. The work of the Beyond Budgeting Round Table (Hope and Fraser, 2003 and
Hope, 2006) have shown that a number of successful organizations have broken free from the
traditional model and created a management model that is much more in tune with today’s
turbulent and complex market conditions. In making this change SMEs need to adopt a
similar management model and move to a new form of financial planning that supports rather
than undermining this model.
3. Manage through continuous planning cycles
Adaptive organizations believe that discontinuous change is now the norm. They see
financial planning as a continuous, inclusive process, driven by events (such as the launch of
a new product or a competitive threat) and emerging knowledge, and not constrained by the
financial year-end. Nor does it need sophisticated tools. Instead it relies on fast, relevant
(actionable) information and responsible people who know what is expected of them and
what to do in any given situation. In companies subject to continuous change it might be
appropriate to set regular (monthly or quarterly) strategic reviews (Southwest Airlines holds
them quarterly), or to make a review dependent on some significant event (Svenska
Handelsbanken branch teams respond to events). These events can be positive (e.g
introducing new products and services) or negative (e.g. reacting to supply chain disruptions
of environmental disasters). The whole point is that these reviews are not time-dependent and
thus can occur as and when needed, not once a year as with the traditional budgeting process.
Transforming financial planning in SMEs
June 2007
© BBRT 2007 – All rights reserved
Page 4 of 14
Figure 1 - The Check-Aim-Plan-Act Cycle
BUSINESS UNITS
CORPORATE CENTRE
Aspirational goals and
strategic guidelines
• Where are we right now?
• What does the short-term
future look like?
Manage resources
Check
Reporting and control:
Actuals vs prior periods
Trends inc forecasts
KPIs
• Are we on a
trajectory to meet our
aspirational goals?
• Does our strategy
need to change?
Aim
Act
Plan
Group rolling forecasts
• What actions do we need to
take to improve our performance?
• What impact will these actions
have on our performance?
Forecast
• What resources do we need?
• When do we execute the plan
The planning cycle has four steps: check, aim, plan and act1 (see figure 1)
•
Check- it starts with check. Where are we right now? What does the short-term
future look like?
•
Aim – the next step is aim. Are we on a trajectory to meet our aspirational
goals? Does our strategy need to change?
•
Plan – the third step is plan. What actions do we need to take to improve our
performance? What impact will these actions have on our performance?
•
Act – the fourth step is act. How should we execute the plans and manage the
existing business?
Note that nowhere in this check-aim-plan-act cycle has the team made a commitment to
a higher authority to reach a specific target; in other words there is no fixed performance
contract. All the commitment to improve is within the local team. This taps the power of
intrinsic motivation (McGregor’s Theory Y). It is the team that set the goals and plans and it
is the team that has the drive to make them succeed. This local check-aim-plan-act cycle is
typical of many adaptive organizations. But the key to success is that it is driven locally by
people who want to improve their relative performance.
4. The dangers of the fixed performance contract
Most companies have some form of individual incentive scheme. Often this is built
around the idea of setting fixed targets and then paying a bonus if individuals reach this
1
This sounds familiar to Dr Deming’s ‘Plan-Do-Check-Act’ (PDCA) cycle, but in fact it’s quite different.
Deming was referring to a manufacturing system or sub-system, whereas we are referring to a business planning
system. For example, when Deming talked about ‘plan’ he meant have an idea for improving the system; check
was ‘see if the idea works’; ‘do’ was put it in the line and ‘act’ was ‘go live’.
Transforming financial planning in SMEs
June 2007
© BBRT 2007 – All rights reserved
Page 5 of 14
target. This system is based on the belief that people are inherently lazy and need to be
motivated by extrinsic factors, primarily money (McGregor’s Theory X). This process
becomes a fixed performance contract: if you reach this target during this period we will pay
you this bonus, and the resources and the targets are built into the budget.
How does this work in practice? Top management sets goals and strategic guidelines
(often these goals are to achieve fixed targets such as a profit of EBITDA2 number by yearend). From these individual targets are set, incentives are aligned, actions agreed, resources
allocated and plans coordinated. This results in the Budget and the fixed performance
contract. Variances to budget are then analysed resulting in re-budgeting. The whole system
is designed to keep on track to ensure that the numbers first thought of by top management
are achieved, no matter how market and world conditions have changed. The basic message
is just stick to your budget and hit the numbers.
This whole process results in gaming, sub-optimal performance and encourages
behaviours that are not aligned with the company’s real objectives. Lengthy negotiations
ensure over the targets and resources (budget). Managers are seeking to agree on the lowest
target with the maximum resources, whereas top management are seeking the reverse.
Eventually both sides (it is adversarial) will agree on something in the middle and both sides
think that they have won. In fact no one wins and the company gets sub-optimal performance.
But it doesn’t stop there, once the individual targets are agreed the manager will manage his
or her own performance to ensure that they achieve the target (and hence their bonus) no
matter what. If we consider the example in Figure 2
Figure 2 – the problem with incentives
Total salary
and bonus
Incentive
stops here
Incentive
starts here
B
Cap
A
“Move
profits into
next year”
Hurdle
“Pull next
year’s profits
forward”
Salary
“Hold
profits
back”
80% of
Target
Budget
Target
120% of
Target
Performance
outcome
Adapted from HBR article “Corporate Budgeting is Broken – Let’s Fix It” by Prof. Michael Jensen, Emeritus, Harvard Business School.
The budget target has been finally agreed, the company agreed to start the incentive
payment if the individual gets within 80 percent of the target (the hurdle), but it also caps the
incentive payment at 120 percent of the target. If the individual feels that they won’t reach
the hurdle they will hold back results in case they need them next year to reach the hurdle. If
they reach the cap they can’t earn any more so they will tail off their performance and move
result to next year in case they don’t reach the hurdle. Such schemes encourage dysfunctional
behaviour.
If you don’t already have such a process, don’t introduce it. It retards fast response, it
stifles innovation, it encourages a ‘spend it or lose it’ mentality, it discourages customer
2
EBITDA: earning before interest, tax, depreciation and amortization.
Transforming financial planning in SMEs
June 2007
© BBRT 2007 – All rights reserved
Page 6 of 14
intimacy; it undermines team working and leads to dysfunctional or even unethical
behaviour. If you already have such a system get rid of it. Separate targets from planning,
consider removing the budget altogether and move to a reward system that is team and/or
company-wide based on progress towards relative aspirational goals.
5. Make rolling forecasts the primary management tool
How can we manage without fixed targets, budgets and fixed incentives? Most leadingedge organizations use rolling forecasts and rolling frameworks as one of their main tools.
Planning is about the future and uses forecasts as its basis. Many companies have introduced
rolling forecasts in addition to the budget process. However, the mistake most managers
make is assuming that forecasts are about ‘predicting and controlling’ future outcomes. The
result is the inevitable ‘hockey stick’ effect to the forecast where they show that the forecast
will meet the fixed targets and the budget. Forecasting is only necessary because
organizations can’t react instantly to changing events. That’s why fast reaction is more
important than (even accurate) prediction. But accuracy is rarely achieved; the only certainty
about a forecast is that it will be wrong. The only question is by how much. Narrowing that
variation comes from learning, experience and decent information systems. Acting on a
forecast renders it obsolete as it has changed the subsequent events and therefore a new
forecast is required taking into account the new changes.
Rolling forecasts, if well prepared3, form the basis of a new and much more useful
information system that connects all the pieces of the organization together and gives senior
management a continuous picture both of the current position and the short-term outlook.
They are the aggregate of ‘business as usual’ forecasts (extrapolations of existing trends), all
the action plans in progress and all the plans in the pipeline. They should be base line plus
anticipated events with the effort being focused on events. An honest view (or one that avoids
dysfunctional behaviours) has no bias so managers should expect to see half their forecasts to
be on the high side of actual outcomes and half on the low side. The ideal forecast has ‘clean’
data that enables managers to improve decision-making. Forecasts must not be seen as
commitments otherwise bias and distortion (dirty or manipulated data) will be inevitable and
the process becomes corrupt. Hence implementing rolling forecasts under the umbrella of
fixed targets and the fixed performance contract rarely works.
Leading organizations are placing forecasting at the centre of their management
process. It becomes an essential tool for business managers to support the decision-making
rather than just another tool that has to be fed. These forecasts need to be light and quick,
which means focusing on only a few key drivers (or key performance indicators - KPIs). It
should only take a day or two each time and is best done by the businesses team itself with
support from the finance team.
5.1. Rolling forecasts in action
Many forecasts only roll as far as the financial year-end as they are aimed at ensuring
that the organisation is on track to meet its fixed targets. These forecasts are not aimed at
supporting strategy and so there is often a gap approach year-end when no one is focusing on
future performance. For this reason leading-edge companies have moved to rolling forecasts
(often quarterly) that roll beyond the year-end. Figure 3 shows how they work.
3
Often forecasts are not well prepared due to such factors as poor project management, ‘rational’ behaviour in
an irrational system and a lack of understanding of the importance of bias and variation.
Transforming financial planning in SMEs
June 2007
© BBRT 2007 – All rights reserved
Page 7 of 14
Figure 3 – A 5-quarterly rolling forecast
Year x
Q1
Q2
Q3
Year x+1
Q4
Q1
Q2
Q3
Q4
1st Review
2nd Review
3rd Review
4th Review
Forecast
Actuals
Let’s assume that the company is approaching the end of quarter one. The management
team gets the rough figures for that quarter and starts to review the next four quarters ahead.
Three of those quarters are already in the previous forecast so they just need updating.
However, a further quarter needs to be added (Q1 for next year). By definition the fiscal yearend is always on the 12 or 18-month rolling forecast screen. In addition the 4th review in
figure 3 provides the baseline plan for the next fiscal year.
Figure 4 shows a graphical representation for a KPI. It shows that at each review the
previous quarter has actuals that can be compared to the forecast. The point of using both
actuals for past quarters and forecasts for the coming quarters is twofold:
1. To learn if the forecasting quality is improving and how it can be further
improved
2. More importantly to highlight and changes in trends between actuals and
forecast which would require clarification
This should not be used to attribute blame but be seen as a learning exercise both for
the team and the company. The most important communication from the forecast is not the
actual numbers, but the trends.
Transforming financial planning in SMEs
June 2007
© BBRT 2007 – All rights reserved
Page 8 of 14
Figure 4 – Rolling framework
Internal accounting presentation
Cost
centre
Current
period
Quarterly costs
($000’s)
Same
period last
year
12 month
moving
average
Moving average
12 months
Actual
quarterly costs
60
Current
year-todate
% change Moving
average
over last
year
Medium-term
KPI target
54
48
42
36
Actual
Forecast
30
Q1
Q2
Q3
Q4
Q5
Q6
Q7
Q8
Q9
Q10
Plotting the moving average totals (MATs) for the actuals and the forecasts shows the
trend for each KPI and any sudden unexplained changes. It can also show progress towards
aspirational goals. Figure 4 shows that the quarterly actuals and forecasts have some “noise”
but plotting the MATs smoothes out this noise.
Figure 5 – Constantly managing performance gaps
Net Profit
20%
X
World Class
benchmarks
“Gap”
Goals
10%
Baseline
2000
2001
2002
Actuals
Project initiatives
2003
2004
2005
2006
2007
Forecasts
Steady state changes
Figure 5 shows another example in which the performance is plotted over time. In this
case a steady-state change indicates that the performance won’t reach the baseline, let alone
the aspirational goal. Adding in planned improvement projects improves the performance
above the baseline, but it still shows a gap to the goal. This gap can only be managed with
further improvement projects, the effects of which will show up in future forecasts.
Transforming financial planning in SMEs
June 2007
© BBRT 2007 – All rights reserved
Page 9 of 14
5.2. Forecasting accuracy
Many companies strive for ever greater forecasting accuracy, which they believe can be
achieved with greater forecasting detail. This is not rational as given that each forecast is
prone to error (after all it is the future we are considering), then the more forecasts we
combine the greater will be the error as one mistaken assumption impacts upon another.
Many organizations fail to let go of the detail and end up with four budget-type cycles per
year instead of one. The details should be left to the front-line units to manage and not
escalated up the organization.
5.3. Making forecasts a management not a measurement process
Forecasts must not be seen by top management as a tool for questioning or re-assessing
performance targets. Nor must they be used to demand changes or improvements. If forecasts
are used in this way to demand immediate improvements from front line teams, then trust and
confidence will rapidly evaporate. This challenges the strong culture of “command and
control” and the lack of systems thinking in many organizations.
Forecasts should be used to support strategy reviews and test the impact of strategic
options. Tomkins a multinational conglomerate made a number of significant changes at the
corporate level. They abandoned the traditional budget at the corporate level, it made no
sense anyway as the business units operate in completely different market sectors with
different dynamics. They abandoned negotiated fixed targets with their business units, instead
they put in place a performance framework of 10:10:10 (10% sales growth, 10% profits
growth and 10% return on capital employed) They then changed their incentive scheme to
one in which teams are rewarded on growth over prior years. This had a big effect on
behaviour; managers now focus on improvement rather than the numbers. Rolling forecasts
were implemented where monthly ‘flash’ forecasts are done in the middle of the month
project to the end of the month and two months ahead. Quarterly rolling forecasts also look
18 months ahead. Rolling forecasts are now the primary management tool. Finally the
reporting system was change to one of actual versus prior year plus trend analysis.
When asked if the organization had become more adaptive through these changes, CFO
Ken Lever remarked “Undoubtedly; we are able to respond much more quickly to whatever
comes up. For example, in the third week of January 2005 we had forecasts for the first
quarter. So if there are any areas where we see a weakness, we have a dialogue with those
businesses about how we can address these weaknesses. Under the old system we wouldn’t
have got to that point until the middle of February so we are three weeks ahead of the game.
We have two-weekly management calls around the group based on current forecasts. The
benefits are tangible. All business teams are now focused on delivering their strategy and
dealing with threats and opportunities as they arise; it’s made us a much more dynamic
organization.”
Toyota is a well-known example of a sense-and-respond organization. Instead of
pushing products through rigid processes to meet sales targets, its operating systems start
from the customer – it is the customer order that drives operating processes and the work that
people do. The point is that in sense-and-respond companies, predetermined plans and fixed
performance contracts are an anathema and represent insurmountable barriers; which is why
adaptive organizations like Toyota don’t have them. However, in industries such as
manufacturing planning has a vital role to play as they have ensure that they will have
sufficient capacity for expected levels of customer orders and they have to manage and
coordinate the supply chain. Every year Toyota Motor Europe develops what it calls its
Transforming financial planning in SMEs
June 2007
© BBRT 2007 – All rights reserved
Page 10 of 14
Original Business Plan (OBP). The OBP is just a forecast (or financial plan) for the year and
provides a baseline for understanding actuals and changes, for communicating, discussion
and reaching consensus (a key element of Toyota’s way of working) and also for
management reviews. The OBP doesn’t have any of the toxic elements of a traditional
budget, such as agreeing and coordinating fixed targets, rewards and resources for the year
ahead, and the measuring and controlling performance against such an agreement. Nor is it a
reference for bonuses etc. as it doesn’t contain any targets or goals (aspirational goals are set
separately by Toyota). Toyota Motor Europe also undertakes quarterly forecast to update the
OBP. These are much lighter than the OBP and don’t go into much detail.
Joseph Bragdon (Bragdon, 2006) describes Toyota as having a highly decentralized and
networked organizational structure; an evolved system of management by means; product
leadership in terms of design for environment and life cycle assessment; a logistics
management system that projects its values and production methods down its supply chain;
progressive ways of connecting with and serving the communities in which it operates; and a
highly evolved systems thinking capacity - all the attributes to which SMEs aspire.
6. Managing costs through trends
You may ask how can we manage and ‘control’ costs. Many successful Beyond
Budgeting organizations set simple cost ratios to guide the front-line teams. Take the example
of Handelsbanken, a highly successful Nordic bank. Thirty years ago the then CEO, Dr. Jan
Wallander realised that the only way to be successful was to devolve power and
responsibility to the branches, in effect make the branches the bank (removing the traditional
budget was necessary as this was seen as having a centralizing effect). Now each branch
“owns” its customers and is a profit centre and report their cost-to-income ratio and profit on
a monthly basis. Branch managers have a ‘standard cost to income ratio of about 40 percent.
Thus managers know whether the business is growing or declining they must constantly
adjust costs and revenues to remain within the guidelines. But these limits are not set in terms
of “budget lines”; managers have complete discretion to over how increase revenue and/or
cut costs in accordance with the level of the business. The responsibility remains with the
local team.
Another approach to controlling costs without fixed budgets is to give clear indications
of the resources that managers can anticipate over the medium-term give the strategic
priorities agreed. These indications are typically in the form of expenditure directions (e.g.
three years) set in relation to the latest twelve months’ actual expenditure. This gives a
message that the current spending level to follow this trend. Over the next three years (or
whatever the period) the resources should be managed so that the level of spend moves in this
directions.
This can be done by setting ratios (e.g. cost-to-income ratios), or moving averages (e.g.
a 2 percent decrease over a period) and then managing business unit or cost (or profit) centre
performance by exception. In this way the local units are given the responsibility of
managing their own costs and making informed decisions. Top management is no longer
having to use the demotivating blunt instrument of the across the board budget cuts. At one
company, accountability was devolved to operating managers who monitored trends within a
medium-term target. No specific targets were set for costs (except for a “default” reduction
level of between 0-2%) unless there was a step-change required. In the absence of such a
step-change, costs were just tracked on a monthly moving average basis. A large
Transforming financial planning in SMEs
June 2007
© BBRT 2007 – All rights reserved
Page 11 of 14
petrochemicals company used this approach successfully to reduce its fixed costs by 30
percent over 5 years.
This is an important part of the reporting system. There is no “micro” picture, no
drilling down, just the broad-brush view of cost trends. Nor does it require an annual review;
it is a rolling system of cost management. This overcomes the “use it or lose it” mentality and
the sandbagging with contingencies. The moving average picture is sufficient for most
purposes; it answers the broad questions such as: “Are costs under control?” and “Are they
moving in the right direction?” This approach gives leaders more control than they ever had
before, point reinforced by Gary Crittenden, CFO of American Express when he said that,
“paradoxically you have more control in a rolling process than in a static one. In a static
process you use the plan as the reference point for control, whereas a rolling process is
constantly informing and regulating itself about what’s happening.” (Hope, 2005)
ALDI, arguably one of Germany’s most successful retailers has focused on removing
(or not creating) the “management factory”4 so often built up with command and control and
instead devolving responsibility for cost management to self-managed teams (at the store
level). ALDI has a “doing without checklist” that contains the following points (Brandes,
2005):
•
No staff to relieve management of intellectual work
•
No controlling department to provide direction
•
No budget forecasts
•
No scientifically cleaned statistics that reveal all
•
No ISO 9000 or TQM
•
No differentiated price policy by sales area or store type
•
No differentiated product mix from store to store
•
No games involving qualities to optimize profits
ALDI has cut out huge amounts of work and cost that exists in most organizations to
control front line operations. In addition, there are no large central functions such as
marketing, management accounting and information systems. Instead, responsibility for
decisions and accountability for outcomes rests with the store teams. ALDI believes in
keeping everything as simple as possible. Continuous improvements ensure that ‘simple’ is
not only well executed but perfected. The customer is always the prime consideration in all
decisions. The establishment of small autonomous units has reduced the amount of
communication and coordination, and the risk of bad decisions being taken remotely. This
allows closer contact with the market and the customers as well as being faster. It is also one
of the best ways to reduce complexity and it enables many more people to feel that they are
‘running their own business’.
7. Making it work
As an SME grows the increase in volume of data and the capability to deal with the
data becomes a major challenge for senior management. They find their in-trays and email
4
The management factory is the whole industry that builds up in command and control organizations around
tools and techniques such as targets and incentives, budget contracts, balanced scorecards, ABC systems, ISO
9000, six sigma etc.
Transforming financial planning in SMEs
June 2007
© BBRT 2007 – All rights reserved
Page 12 of 14
systems increasingly overloaded. They can’t be all-knowing in every aspect of the business
and make sensible decisions on a day to day basis. Thus they are always reacting and reacting
again and the stress builds up. A powerful way of managing this increasingly complex
situation is to devolve planning and decision-making to the front-line teams (this was already
foreseen by Prof Hans-Jürgen Warnecke back in the early 1990s (Warnecke, 1993)). If senior
managers create the capacity for people lower down the organisation to make the right
decisions and act on them, they can filter out a lot of data that would otherwise end of on the
desks of top management. Top management doesn’t need to get involved in the detail of the
front line units; they just need to monitor the whole unit and react if they see patterns and
trends change in a way that riggers an alert on the senior management radar screen. This
leads to fewer people handling data and therefore less scope for error and misreporting.
The organizations studied by the Beyond Budgeting Roundtable (BBRT) show time
and again that continuous planning and forecasting can only work effectively when power
and authority is devolved to the front line units. All the time it remains at the centre it is in
danger of becoming a quarterly budget process and all the bad behaviours continue. The only
way to make the change is through devolution. All the commitment to improve is then within
the local team, which taps the power of intrinsic motivation (McGregor’s Theory Y). It is the
team that sets the goals and plans and it is the team that has to drive to make them succeed.
The role of corporate centre is to set strategic direction together with clear operating
guidelines, governance procedures and performance standards. They also have a clear
monitoring role. Corporate centre use the rolling forecasts and trends to check that each unit
is ‘within bounds’ in terms of agreed performance indicators and then only interfere if they
are not. This local check-aim-plan-act is typical of many adaptive organizations, but the key
to success is that it is driven locally by people who want to improve their relative
performance.
Leading organizations share some common attributes that enable the devolution of
strategy:
2. They make accountability for strategy clear down the line. Teams know their
scope of authority and the results for which they are accountable.
3. Teams share a common language for discussing strategies and a common
process for developing them
4. They have skilled strategic thinkers who engage in a continuous dialogue about
strategy
5. They actively encourage and support free, rigorous and fact-based debate. There
is a ‘no blame’ culture that enables ideas to circulate freely. Mistakes are
recognised as a learning opportunity both for the individual and the organization
6. They provide a climate where people can pursue long-term performance goals.
Thinking strategically requires more extended perspective than managing for
quarterly results. The policies, style and incentives of an organization must
reward this kind of outlook but most often they do not.
Removing the fixed performance contract, replacing the traditional annual planning and
budgeting process with continuous planning cycles and devolving power and authority to
front line teams enables a company to achieve a much higher degree of adaptability and
responsiveness and hence higher and sustainable profitability than would otherwise have
been possible. It enables the company to re-create the benefits of an SME by effectively
allowing each and every unit to act like its own small business, but the some coordination
from the top to achieve the common goals.
Transforming financial planning in SMEs
June 2007
© BBRT 2007 – All rights reserved
Page 13 of 14
If you are a small or medium sized company and have not yet adopted the traditional
budgeting process with its fixed performance, then DON’T. It will only lead to loss of
adaptability and responsiveness, and loss of customer intimacy, the very attributes that make
you successful today. Instead move to a form of financial planning that will enable you to
manage your business more effectively as it grows whilst still retaining the attributes of a
small company.
8. Acknowledgments
The author would like to acknowledge the assistance provided by his fellow BBRT
Directors in the preparation of this paper: Jeremy Hope, Robin Fraser, Franz Röösli and Steve
Player.
References
Bragdon, J.H. (2006) Profit for Life: How capitalism excels. Cambridge, MA: Society for Organizational
Learning
Haeckel, S. (1999) The Adaptive Enterprise. Boston, MA: Harvard Business School Press
Hope, J. and Fraser, R. (2003) Beyond Budgeting: how managers can break free from the annual performance
trap. Boston, MA: Harvard Business Review
Hope, J. (2005) Interview with Gary Crittenden, 14 February 2005
Hope, J. (2006) Reinventing the CFO: How financial managers can transform their roles and add greater value.
Boston, MA: Harvard Business School Press
Warnecke, H-J. (1993) The Fractal Company: A revolution in corporate culture. Berlin: Springer-Verlag
Transforming financial planning in SMEs
June 2007
© BBRT 2007 – All rights reserved
Page 14 of 14