Custom Search

THREE REQUIREMENTS FOR EFFECTIVE PLANNING

Forecasting. The firm will never have perfectly accurate forecasts. If it did, there would be less need for planning. Still, managers must strive for the best forecasts possible.

Forecasting should not be reduced to a mechanical exercise. NaР РЈР їve extrapolation or fitting trends to past data is of limited value. Planning is needed because the future is not likely to resemble the past.

Do not forecast in a vacuum. By this we mean that your forecasts should recognize that your competitors are developing their own plans. For example, your ability to implement an aggressive growth plan and increase market share depends on what the competition is likely to do. So try putting yourself in the competition`s shoes and think how they are likely to behave. Of course, if your competitors are also trying to guess your movements, you may need the skills of a good poker player to outguess them. For example, Boeing and Airbus both have schemes to develop new super-jumbo jets. But since there isn`t room for two producers, the companies have been engaging in a game of bluff and counterbluff.

Planners draw on information from many sources. Therefore, inconsistency may be a problem. For example, forecast sales may be the sum of separate forecasts made by many product managers, each of whom may make different assumptions about inflation, growth of the national economy, availability of raw materials, and so on. In such cases, it makes sense to ask individuals for forecasts based on a common set of macroeconomic assumptions.

Choosing the Optimal Financial Plan. In the end, the financial manager has to choose which plan is best. We would like to tell you exactly how to make this choice. Unfortunately, we can`t. There is no model or procedure that encompasses all the complexity and intangibles encountered in financial planning.

You sometimes hear managers state corporate goals in terms of accounting numbers. They might say, “We want a 25 percent return on book equity and a profit margin of 10 percent.” On the surface such objectives don`t make sense. Shareholders want to be richer, not to have the satisfaction of a 10 percent profit margin. Also, a goal that is stated in terms of accounting ratios is not operational unless it is translated back into what that means for business decisions. For example, a higher profit margin can result from higher prices, lower costs, a move into new, high-margin products, or taking over the firm`s suppliers.1 Setting profit margin as a goal gives no guidance about which of these strategies is best.

So why do managers define objectives in this way? In part such goals may be a mutual exhortation to work harder, like singing the company song before work. But we suspect that managers are often using a code to communicate real concerns. For example, a target profit margin may be a way of saying that in pursuing sales growth the firm has allowed costs to get out of control.

The danger is that everyone may forget the code and the accounting targets may be seen as goals in themselves.

Watching the Plan Unfold. Financial plans are out of date as soon as they are complete. Often they are out of date even earlier. For example, suppose that profits in the first year turn out to be 10 percent below forecast. What do you do with your plan? Scrap it and start again? Stick to your guns and hope profits will bounce back? Revise down your profit forecasts for later years by 10 percent? A good financial plan should be easy to adapt as events unfold and surprises occur.

Long-term plans can also be used as a benchmark to judge subsequent performance as events unfold. But performance appraisals have little value unless you also take into account the business background against which they were achieved. You are likely to be much less concerned if profits decline in a recession than if they decline when the economy is buoyant and your competitors` sales are booming. If you know how a downturn is likely to throw you off plan, then you have a standard to judge your performance during such a downturn and a better idea of what to do about it.