Throughout this book, I've been reinforcing as much as I could that it's about planning, not the plan. In this chapter I want to gather all the pieces together and drive that point home.
This chapter is about planning as management.
|Plan vs. Actual Analysis
||It's not just accounting, or the technical term variance. It's about the management that results from it.
|Management and Accountability
||It doesn't happen automatically. Accountability is a matter of setting the right metrics and tracking performance. This should be part of the planning process.
|Crystal Ball and Chain
||Realize that some people fear metrics and planning as something that will be used against them in the future. Avoid this problem by making sure it's collaborative.
|Set Expectations and Follow Up
||The secret of management is setting expectations and following up with reviews of performance. This is part of your planning process.
Let's look at a simple example of how plan vs. actual analysis works.
For the record, in accounting and financial analysis they call the difference between plan and actual variance. It's a good word to know. Furthermore, you can have positive or negative variance, as in good variance and bad variance.
- It comes out as a positive number.
- If you sell more than planned, that's good. If profits are higher than planned, that's good too. So for sales and profits, variance is actual results less planned results (subtract plan from actual).
- For costs and expenses, spending less than planned is good, so positive variance is when the actual amount is less than the planned amount. To calculate subtract actual costs (or expenses) from planned costs.
- The opposite. When sales or profits are less than plan, that's bad. You calculate variance on sales and profits by subtracting plan from actual.
- When costs or expenses are more than planned, that's also bad. Once again, you subtract actual results from the planned results.
I'd like to show you that with a simple example. Let's start with a beginning sales plan, then look at variance, and explore what it means. This is a simple sales forecast table -- a portion, showing just three months -- from a standard sales forecast.
Beginning Sales Plan
To set the scene, this illustration shows the sales forecast as the business plan is finished.
Actual Results for Sales
The next illustration shows the actual results for the same company for the first three months of the plan.
The numbers at the end of March show actual sales numbers plus adjustments and course corrections.
So the calculations are simple enough. You calculate the variance in sales by subtracting the planned amount from the actual amount, which gives us the table shown below.
I use the classic accountant's red to indicate negative numbers, as in the phrase "in the red." The negatives are also in parentheses. For those cases, the actual sales were lower than planned. Positive numbers here mean actual sales were higher than planned.
You probably see some obvious conclusions. These are just numbers, but they are also indicating areas for more management.
- The negative results for unit sales of systems are well below plan. And the per-unit revenue is down too.
- Although units of service are disappointing, the price per unit was up, so sales were above plan.
- There were pleasant surprises as well for software and training.
Given what's happened with the sales results, the plan-as-you-go planning process indicates in this example that systems sales are going badly, but there are other sales that can make up the problem.
Do you change the plan? That's where the management comes in. Get the people together and talk about it. Why are systems sales so much less than plan? Were the assumptions wrong? Was the plan too optimistic? Has something happened -- new competition, for example, or new technology, or something else -- to change the situation as it was planned.
What about the people? Here's where you have to manage expectations and follow up. Do you have metrics on sales presentations, leads, close rates? Have the people been performing, but just not getting the sales? Was your pipeline assumption wrong?
For this example, let's say we decide to adjust the sales forecast to absorb some changed assumptions. The next illustration shows the new sales forecast, after adjustments.
The illustration shows the revised plan in the April and May columns, even before they happen, to reflect the changes shown in the January-March period. Why would we work with an obsolete plan when the situation has changed.
Does this blow the plan vs. actual comparisons for future months? Not if you make the changes correctly, with everybody on the team being aware of them. You just keep moving your plan forward in time, revising for future months.
In the end, it's not a game. So what if you change the scoring in the middle. The point is managing the company better. Since the company knew systems sales would be down, it has planned on it and made a revised forecast in the actuals area. The same revision affects projected profits, balance sheet, and — most important — cash.
One of the more stubborn recurrent paradoxes in all business planning is the problem of consistency vs. the brick wall.
Consistency refers to a fact of life in small business strategy: it's better to have a mediocre strategy consistently applied over three or more years than a series of brilliant strategies, each applied for six months or so. This is frustrating, because people get bored with consistency, and almost always the people running a strategy are bored with it long before the market understands it.
For example, I was consulting with Apple Computer during the 1980s when the Macintosh platform became the foundation of what we now call "desktop publishing." We take it for granted today, but back in 1985 when the first laser printers came out, it was like magic. Suddenly a single person in a home office could produce documents that looked professional.
People might argue with this, but what I think I saw in Apple at that time was smart young managers getting bored with desktop publishing long before the market even understood what it was. They started looking at multimedia and other bright shiny new things, lost concentration on desktop publishing, and lost a lot of market potential as Windows vendors moved in with competitive products.
The brick wall, on the other hand, refers to the futility of trying to implement a flawed plan. You've probably run into this problem at times. People insist on doing something "because that's the plan" when in fact it just isn't working. That kind of thinking has something to do with why some Web companies survived the first dotcom boom and others didn't. It also explains why some business experts question the value of the business plan. That's sloppy thinking, in my opinion, confusing the value of the planning with the mistake of implementing a plan without change or review, just because it's the plan.
This consistency vs. revision paradox is one of the best and most obvious reasons for having people -- owners and managers -- run the business planning, rather than algorithms or artificial intelligence. It takes people to deal with this critical judgment.
One good way to deal with it is focusing on the assumptions. Identify the key assumptions and whether or not they've changed. When assumptions have changed there is no virtue whatsoever in sticking to the plan you built on top of them. Use your common sense. Were you wrong about the whole thing, or just about timing? Has something else happened, like market problems or disruptive technology, or competition, to change your basic assumptions?
Do not revise your plan glibly. Remember that some of the best strategies take longer to implement. Remember also that you're living with it every day; it is naturally going to seem old to you, and boring, long before the target audience gets it.
Following the previous sales example, the planned profit and loss table in the next illustration shows a portion of the profit and loss for the sample company, as it stood in the original plan.
This table shows the gross margin and sales and marketing expense area of the original plan. This is a portion of the full table.
The next illustration shows the actual results recorded in that portion of the profit and loss, after the end of March. The actual results mean little without comparison with the original profit and loss table, shown previously. Unfortunately, many businesses also forget to compare the original plan to the actual results. Especially if business is going well -- the operation shows a profit, and cash flow is satisfactory -- comparisons with the original budget are made poorly or not at all.
The table shows actual results. Note how actual sales, costs, and expenses are different from the planned numbers. This is a portion of the full table.
So here's the significant view, the variance. Sales are below plan, but costs are also below plan, and let's stop there and make a point. You can see in the illustration how sales are negative and costs are positive. If you weren't careful, you could interpret that as sales are down and costs up, which would be a disaster. But variance analysis is fairly specific, defined by accountants and financial analysts, so the positive in the direct costs lines means less costs, not more. That can be tricky.
You can check on that by looking at the gross margin. The gross margin is disappointing, below plan, but not horribly so. It seems like the cost controls helped soften the blow of lower sales.
Then you start looking at the expense rows, and there are several interesting surprises.
This is where we go from the accounting details, the actual calculation, to the human details. What happened here? What should be changed? Does the plan need revision? Have assumptions changed. How have the people performed?
So we've seen some simple examples, in sample financial statements, of how things can go differently than planned. The real management here isn't just the calculations, but rather the management of the differences.
You have to look beyond the numbers, talk to the people, bring these things up in the meetings so the plan stays alive as planning, and becomes management. It isn't always obvious.
Many businesses, especially the small, entrepreneurial kind, ignore or forget the other half of the budgeting. Budgets are too often proposed, discussed, accepted, and forgotten. Variance analysis looks after the fact at what caused a difference between plan and actual numbers. Good management looks at what that difference means to the business.
Variance analysis ranges from simple and straightforward to sophisticated and complex. Some cost-accounting systems separate variances into many types and categories. Sometimes a single result can be broken down into many different variances, both positive and negative.
The most sophisticated systems separate unit and price factors on materials, hours worked, cost-per-hour on direct labor, and fixed and variable overhead variances. Though difficult, this kind of analysis can be invaluable in a complex business.
Look for Specifics. Talk to the People
This presentation of variances shows how important good analysis is. In theory, the positive variances are good news because they mean spending was less than budgeted. The negative variance means spending was more than the budget.
Continuing with our example, the $5,000 positive variance in advertising in January means $5,000 less than planned was spent, and the $7,000 positive variance in literature (meaning collaterals, such as brochures, sales pamphlets and folders) in February means $7,000 less than planned was spent. The negative variance for advertising in February and March and the negative variance for literature in March show that more was spent than was planned for those items.
Evaluating these variances takes thought. Positive variances aren't always good news. For example:
- The postive variance of $5,000 in advertising means that money wasn't spent, but it also means that advertising wasn't placed. Systems sales were way below expectations for this same period -- could the advertising missed in January be a possible cause?
- For literature, the positive $7,000 in February may be evidence of a missed deadline for literature that wasn't actually completed until March. If so, at least it appears that the costs on completion were $6,401, a bit less than the $7,000 planned.
Among the larger single variances for an expense item in a month shown in the illustration was the positive $7,000 variance for the new literature expenses in February. Is this good news or bad news? Every variance should stimulate questions.
- Why did one project cost more or less than planned?
- Were objectives met?
- Does a positive variance reflect a cost saving or a failure to implement?
- Does a negative variance reflect a change in plans, a management failure, or an unrealistic budget?
A variance table can provide management with significant information. Without this data, some of these important questions might go unasked.
More on Variance
Variance analysis on sales can be very complex. There can be significant differences between projected and actual sales because of different unit volumes, or because of different average prices. In the sales variance example in this chapter, the units variance shows that the sales of systems were disappointing. In the expenses variance, however, we can see that advertising and mailing costs were below plan. Could there be a correlation between the saved expenses in mailing, and the lower-than-planned sales? Yes, of course there could.
The mailing cost was much less than planned, but as a result the planned sales never came. The positive expense variance is thus not good for the company. Sales and Marketing expenses were also above plan in March, causing another negative variance.
The sales forecast variance table, shown earlier, which compares units variance and sales variance, yields no surprises. The lower-than-expected unit sales also had lower-than-expected sales values. Compare that with Service, in which lower units yielded higher sales (indicating much higher prices than planned). Is this an indication of a new profit opportunity or a new trend? This clearly depends on the specifics of your business.
It is often hard to tell what caused differences in costs. If spending schedules aren't met, variance might be caused simply by lower unit volume. Management probably wants to know the results per unit, and the actual price, and the detailed feedback on the marketing programs.
The quality of a business plan is measured not by the quality of its ideas, analysis, or presentation, but only by the implementation it causes. It is true, of course, that some business plans are developed only as selling documents to generate financial resources. For these plans, their worth is measured by their effectiveness in selling a business opportunity to a prospective investor. For plans created to help run a business, their worth is measured by how much they help run a business — in other words, their implementation.
Variance analysis is vital to good management. You have to track and follow up on budgets, mainly through variance analysis, or the budgets will be useless.
Although variance analysis can be very complex, the main guide is common sense. In general, going under budget is a positive variance, and over budget is a negative variance. But the real test of management should be whether or not the result was good for business.
Every small-business owner suffers the problem of management and accountability. It's much easier to be friends with the people you work with than to manage them well.
Correct management means setting expectations well and then following up on results. Compare results with expectations. People on a team are held accountable only if management actually does the work of tracking results and communicating results, after the fact, to the people responsible.
Metrics are part of the problem. As a rule we don't develop the right metrics for people. Metrics aren't right unless the people responsible understand them and believe in them. Will the measurement scheme show good performances and bad performances?
The metrics should be built into the plan. Remember, people need metrics. People want metrics.
Then you have to track. That's where the plan-as-you-go business plan creates a management advantage, because tracking and following up is part of its most important pieces. Set the review schedules in advance, make sure you have the right participants for the review, and then do it.
In good teams, the negative feedback is in the metric. Nobody has to scold or lecture, because the team participated in generating the plan and the team reviews it, and good performances make people proud and happy, and bad performances make people embarrassed. It happens automatically. It's part of the planning process.
And you must avoid the crystal ball and chain (see the next section). Sometimes -- actually, often -- metrics go sour because assumptions have chained. Unforeseen events happened. You manage these times collaboratively, separating the effort from the results. People on your team see that and they believe in the process, and they'll continue to contribute.
This is an answer to a question I get way too often. I call it the crystal ball and chain problem. I've run into it several times as I've introduced the planning process into a new company or organization.
People in the organization sometimes fear business planning. In the background, the fear is related to accountability and commitment. Usually they don't realize it. They state their objection like this:
"But how can I possibly know today what's going to happen six months from now? Isn't that just a waste of time? Can't it actually be counterproductive, because it distracts us, and we spend time trying to figure out things in the future?'
I've heard this from some people who really did seem to be worried about accountability and commitment, and I've heard it from some who were stars on the team, not worried at all about their own position, but legitimately worried about the best thing for management and getting work done.
The answer is that projecting future business activities isn't a ball and chain at all, because in the right planning process the existence of the plan helps you manage effectively.
Here's a concrete example: It's September and you are developing your plan for next year, which includes an important trade show in April. You plan on that trade show and set up a budget for expenses related to that trade show. Even though it's September, you have a pretty good idea that this will happen in April.
When January rolls around, though, it turns out that the trade show that normally takes place in April will be in June this year. Does that mean the plan was wasted time? Absolutely not! It is precisely because you have a plan running that you catch the change in January, move the expenses to June, and adjust some other activities accordingly.
In this example, the plan isn't a brick wall you run into or a ball and chain that drags you down; no, it's a helpful tool, like a map or even a GPS (global positioning system) device, because it helps you keep track of priorities and manage and adjust the details as they roll into view.
It's normal for the crystal ball and chain to appear as an objection when a planning process is introduced. The solution is simply good management. The people involved in implementing the plan learn with time how regular plan review sessions help them stay on top of things, and when assumptions change, how the plan changes. Changes are discussed, nobody gets fired, and you have better management.
The underlying idea here is directly related to the paradox I mentioned earlier: business plans are always wrong, but they're still vital to good management.
(Adapted with permission from blog.timberry.com)
I was caught on a plane once with the One Minute Manager book, by Kenneth Blanchard. I recommend that book, it's easy to read -- about one short plane ride's worth -- and easier to absorb. And I feel like it boils down to setting expectations with people and then following up, afterwards, with reviewing performance against expectations. You can add a lot of padding around that basic idea, but essentially it's one of those obvious ideas that's easy to say and hard to do.
Your plan-as-you-go business planning process can become a really valuable way to make that idea real, in your business, and part of your management. What I've found through the years is setting expectations and following up is one of those basic principles like, say, healthy diet and regular exercise. It's easy to understand, everybody agrees that it's good to do, but not everybody manages to make it happen. It's a matter of actually doing what we know we want to, what we know we should.
Honestly, in my years as a company builder, it was really hard to follow up. I think it's a natural process that you end up liking the people you work with, and, as business owner, you tend to work shoulder-to-shoulder. They aren't direct reports or subordinates, in your mind; they are John and Teri and Vie and Cale. They become friends.
So, in the plan-as-you-go world, that need for setting expectations and following up becomes part of the process. Your plan includes the metrics people need so they can know how they're doing. The core of management follow up happens because you have a forum, a comfortable place for that hard-to-do follow up. Your plan is built on metrics for your people, and you look at those metrics regularly. Following up gets easier.
A good business plan is never done. If your business plan is finished, then your company is also finished.
It's a lot like the legendary farmer's axe, that has had its handle changed four times and its blade changed three times, but it's still the same axe.
As your company gets used to the planning process, the business plan is always a work in progress. It gets a big refreshment every year, and a review and course correction every month.
Every so often, as business plan events come up, you spin out of your business plan a formal output piece, whether it's a pitch presentation, an elevator speech, or a full-fledged formal business plan document.
But that's not the plan, that's just output. It's the latest version. But the plan goes on, like steering, walking, dribbling, and navigation.
Don't ever wait for a plan to be done. Get going.
It's a simple statement: all business plans are wrong, but nonetheless vital.
Paradoxical, perhaps, but still very true.
All business plans are wrong because we're human, we can't help it, we're predicting the future, and we're going to guess wrong.
But they are also vital to running a business because they help us track changes in assumptions and unexpected results in the context of the long-term goals of the company, long-term strategy, accountability, and, well, just about everything the plan-as-you-go business plan stands for.