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Attending a user's group conference of a well-known vendor of planning and budgeting software, we were surprised to hear another well-known software company claim it had increased budget accuracy from 85 percent to 93 percent since implementing the vendor's application. That company had just missed its earnings guidance for the sixth straight quarter! Yet the speaker had a point. His company was forecasting spending accurately enough and had been able to hold 93 percent of outlays to that forecast on a line-by-line basis. Was this measure of accuracy important? Certainly it was to some employees but from a shareholder's perspective it was not. Why? The company was doing a terrible job of forecasting its sales and therefore kept missing its guidance. How then should companies measure and assess the accuracy of their plans and budgets?

It depends on your perspective. The main purpose of budgeting used to be fiscal control of spending and managing cash flow, and getting this right is still very important. Accurately communicating objectives to external investors and lenders is important for companies that depend on them. One somewhat imperfect measure of how accurately public companies forecast revenues and earnings is the standard deviation of actual results from consensus estimates over a period of time. For companies that give earnings guidance (as a majority do), analysts' estimates are close proxies of those numbers.

More recently, planning has become a key component of performance management. For internal management, "planning accuracy" and "performance to plan" are closely linked. To make planning more accurate, companies should focus on how well an individual or a business unit achieved key objectives that it could control. For example, where managers control salaries, incentive compensation and staffing levels, they should be accountable for how accurately they forecast head count expenses. If staffing levels are driven by market demand or requirements from other parts of the business, they should be responsible for the accuracy of their cost-per-head projections and the efficiency in servicing demand (for example, number of sales or orders processed per employee).

This example illustrates why we strongly advocate basing planning and budgeting on such drivers. Simply looking at budgeted amounts expressed in monetary terms, it is usually impossible to separate things managers and employees can control from those they cannot. Being able to separate them focuses decisions on what makes business sense and promotes, rather than diffuses, responsibility. So, let's say, when escalating fuel prices drive travel costs higher, it is not helpful to cancel sales calls simply to keep expenses within budget. Instead, focus sales managers on revenue and controllable costs per sales call. Clearly, companies must react as the business environment changes. If rising fuel prices are driving up travel costs, it probably makes sense to find ways to compensate by pursuing efficiencies in other areas. Most companies do this, but in a piecemeal way. Companies that use a "rolling quarters" approach to detailed budgeting are better able to assess their accuracy from one quarter to the next.

We also advocate using external metrics rather than fixed measures to assess performance. If the objective is to grow the top line 15 percent, and the company achieves this but the market grew 20 percent, what is the point of being accurate? In contrast, if the objective is to maintain market share, 20 percent growth should be the objective, and the accuracy of the plan would be measured on this basis.

We have found that accuracy is improved when companies use a high participation approach, one that involves all managers down to the lowest level of the organization. Increasing the frequency of the planning and budgeting processes (quarterly instead of annually) also improves accuracy because there is a shorter lag between when the budget is set and when it is executed.

Assessment

Ventana Research thinks there are several good reasons to plan accurately; fiscal control and communicating to external investors are two important ones. To do these consistently well, we advise companies to adopt a performance management approach to planning. Organizations can improve accuracy of plans and budgets by using a high-participation, high-frequency approach. Dedicated planning and budgeting software addresses the inherent defects of stand-alone spreadsheets that limit participation and frequency. Corporations can ensure that accuracy is also useful by focusing on measuring performance to key metrics that align to their strategy and objectives, as well as modeling the business well. To do this, they need an ongoing process for defining key performance metrics and a means of communicating them. Such a commitment also requires companies to collect, analyze and report financial and operating data and work with internal and external benchmarks.