Monday, November 5, 2007

The Irrelevance of Planning & Budgeting

JEDDAH, 14 February 2005 — Planning is the patent medicine of our day. People are convinced that it will cure all the evils of corporate and government financial affairs. The prestige of the catchword “planning” is so great that the mere mention of it is considered a solution of all financial problems.
Financial planning is a continuous process of directing and allocating economic and financial resources to meet strategic goals and objectives. The output from financial planning takes the form of budgets.
Strategic planning is a formal process for establishing goals and objectives over the long run. Strategic planning involves developing a mission statement that captures why the organization exists and plans for how the organization will thrive in the future. Strategic objectives and corresponding goals are developed based on a very thorough assessment of the organization and the external environment. Thus, this exercise is simply and purely forecasting the future, which is an impossibility in the practical sense. There is no way anyone can predict the future. There are too many changes taking place — markets are constantly changing, customer preferences are changing, new competition, new technologies, new opportunities, etc... Strategic plans could be a waste of time! Poor assumptions, overly optimistic projections, and other bad decisions can result in a bad strategic plan. A bad strategic plan will lead to serious problems for corporations and the country.
Traditional budgeting process starts at least 3 months before the beginning of the fiscal year. Divisions and departments receive their “budget kit” which includes forms asking for forecasts of revenues, expenses and capital expenditures. These forecasts are reviewed by committees, sub-committees and task force teams, and after several rounds of meetings and hundreds of cups of tea and coffee, the budget document is finalized. This vast document lists the capital and operational resources that the government or corporation is to make available to the operating units, the obligations made by each unit for the coming year. Despite the advanced information technology, budgeting remains a protracted and expensive process, absorbing 25 percent of management’s time. Thus, the budgeting process is cumbersome and unreliable.
Originally, the budgeting process emerged almost a hundred years ago in the West as a tool for managing costs and cash flows in large industrial corporations. It was not meant to be used as a fixed performance contract. Companies used various accounting data to keep score of their revenues and expenses, but not to dictate the actions of people at all levels of a country or an organization, as it is used nowadays. Instead of using effective benchmarks such as productivity and marketing efficiencies to drive performance, management began to rely on financial targets and incentives. Rigid adherence to annual fixed plans and budgets stifled innovation and efficient decision-making process.
Many Arab corporations and institutions have invested huge sums in IT networks, process reengineering and a range of modern management tools including balanced scorecards and activity accounting. But they have been unable to improve their efficiency because the centralized hierarchies, the budgets, the command and control culture that it supports remain predominant.
In some cases, use of the budget to force performance improvements could lead to stagnation and breakdown of morale within an organization. Same organizations that “vow” to stay close to the customer (ours customers come first), so that they can respond quickly to new information about market changes, hang tightly to budgeting — a process that disempowers managers and slows the response to market developments.
Budgeting must be abolished once and for all, and replaced by other goals and measures, both financial and non-financial measurements. Each business unit must be judged on how well its performance compares with its peers and against world-class benchmarks. Using such standards, divisions and departments become more entrepreneurial, exploiting opportunities and become more adaptive to an increasing changing business environment. This requires employers to become more effective than meeting budgets. They would measure themselves against how well comparable group inside and outside the organization will turn out to have done in the same period, given the economic conditions prevailing at the time. Because employers won’t know whether they have succeeded or by how much until the period is over, they must be at their best to ensure that their performance is better than that of their peers. Business units, plants, or branches can measure their progress against comparable units within the organization through the use of a few key financial measures.
In order to measure themselves against external peers, they can use operational benchmarks such as return on capital invested. The elements or factors measured are “key performance indicators” — KPI’s such as profits, cash flows, cost ratios, customers satisfaction, employment retention and quality.
In an empowered organization, people are free to make mistakes and equally free to fix them. Managers would have wide discretion making decisions; as a result, they can obtain resources more quickly than in traditional companies.
In lieu of budgeting, organization must adapt to make “automatic quarterly forecasts” (AQF). Since this forecast is regularly revised, it supports managers’ ability to fashion strategies that continuously adapt to market conditions. This AQF differ from traditional budgets in many ways.
It does not envisions a fixed deadline at the end of the fiscal year. When revenues, costs and other elements are measured against (by now) stale targets. It includes only few key variables such as revenues, costs, and capital expenditures which means it can be compiled relatively easily and quickly. Most important, AQF is more accurate, it is constantly updated by the latest economic trends and customer demand and by emerging data from the most recent quarter. More so, no one has a reason to manipulate them, because there are no fixed revenues targets or penalties for missing them.
In conclusion, in organizations that have abolished budgeting, the “spend it or lose it” philosophy that is at work in traditional organizations is eliminated. More so, these organizations can unleash the full power of modern information systems and tools.
Knowledge flows within the organization become more efficient, permitting the full potential of a decentralized organization to be realized.

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