Getting the Annual Budgeting Process Right
An article in the WSJ over the summer criticized the annual budgeting process as leading to bad decisions. The author Mr. Merchant, is the chair of accountancy at USC. His research indicates that many managers find the process a waste of time filled with endless meetings discussing historical data in today’s dynamic world. Too many budgets look back to make decisions on what is going to happen today. At the same time Mr. Merchant comments that the best users of the budgets are opportunists that work the system to enrich their personal bonuses. Others spend foolishly to avoid a reduction in future budgets. Mr. Merchant contends the process is too infrequent, inflexible, and easily manipulated. He talks about dynamic planning to avoid stale plans before they are instituted, flexibility in allocation of resources to take advantage of opportunities as they arise, and avoid using budgets as performance measurers.
After reading the piece it occurred to me that what he says has a lot of merit. It also appears his data base represents larger multifaceted organizations with large bureaucratic institutions. My experience has shown that it is better to manage the budget than excel. People have made millions managing the process and good for them.
Small and middle market organizations usually look to the CFO to develop the “annual budget”. For many the process is looked upon as a process rather than an opportunity to seek new heights and understand what it will take to reach those heights.
You may wish to ask yourself the following:
- Is your client / customer / company (“CCC”) missing strategic opportunities?
- Is your “CCC” planning for changes in market dynamics from product mix to market shifts?
- Is your “CCC” continuously missing their numbers?
- Is your “CCC” missing market opportunities?
- Does your “CCC” understand and communicate what resources are required to be successful?
- Does your “CCC” have the resources necessary to execute its operating plan?
- Does the plan provide detail projections on working capital components?
- Does your “CCC” have financial and operational discipline to be successful?
- Can your “CCC” execute their game plan?
- Is the organization creating vanilla spreadsheets or interactive planning models?
If you respond yes to one or more of the questions it may not be a capabilities issue but a culture issue. How the company’s board and CEO view the planning process will have a great deal to do with the outcome.
If the planning process is looked upon as an opportunity for meaningful dialog on how the company stacks up against the competition, what are the economic opportunities to improve your competitive position, and what resources will it take to improve your competitive position is a first step in creating an open empowering environment.
Example: During one assignment in which a US manufacturer and importer of a home décor refill product was struggling with what direction to take his enterprise and his product line. We were engaged at the urging of a Board member to assist the CEO in the strategic planning process. The owner CEO took the task seriously. The process of creating the interactive planning model requiring him to face his demons, life became more difficult. Demons are not necessarily a bad thing. The decisions tree decision making process and what if analysis took the CEO and staff on a financial walk through of the many decision demons that must be faced from people, equity positions, capital and human resources, plant capacity issues, and the difficult buy or produce conundrum. His walk into the future resulted in different decisions than would have otherwise been made at the outset of the process. In the end he had a much clearer view of what the financial portrait might look like together with an early understanding of some demons he must face.
Islands of Information:
Too many times companies and “C” suite executives’ use off line financial spreadsheets to make business decisions that ultimately fail as the data is unreliable. The best laid out plans can also drift due to outside economic forces. That said, it is our experience that well developed interactive planning models that encompass a complete forecast of operations by division / product line together with detailed analysis of working capital changes, cash flows, debt analysis, capital budgets, all linked to a projected Balance Sheet provide the most meaningful decision tree process. It is important that the developer uses mathematical formulas vs. plug numbers. Personally I loathe plug numbers as it distorts outcomes. In my opinion is it important to let the formulas work as they provide more reliable output in which to make decisions.
Next time you are presented a great opportunity in PowerPoint or summary spreadsheet form ask for a complete financial analysis that starts with the company’s current Balance sheet and historical operating data that is rolled forward as outlined above. With this as a starting point you can then assess the opportunity and request results based upon your economic concerns.
Changing an enterprise from one that reacts to one that is proactive usually requires leadership that understands the benefits of planning and strategizes. This transition usually requires bringing what some call “a professionally managed company” with appropriate financial discipline.
In the land where cash is king, understanding where the cash is coming from and where it is going is only the start. Empowering management and creating interactive team work is the first step in creating a meaningful planning process. Revenue is critical. Understanding which divisions, products and customers are providing positive returns is important. Planning for the future and grasping future opportunities and challenges is what planning is all about.