Here, in Australia, many businesses are reviewing progress after their first month of the new financial year. Most business leaders are finding the unpleasant truth that the budget, so exhaustingly put together just weeks before, isn’t helping very much.
At the same time many people are questioning whether the rise of the mega ERP systems have helped any part of the organisation apart from the finance function. And everyone is familiar with cascading spreadsheets which allow a myriad of numbers to be produced. All of these are guesses; and usually wrong.
Are we letting ourselves down with the way we budget?
I don't think there's any process in organisations that wastes such a large amount of effort and time for little use as the budgeting process. Almost every business of any size has a budgeting process, but most don't really know why they do it. It's a bit like the monkey on the rope story. “It's always been done that way so we’d better carry on otherwise something terrible will happen.”
It's all about Clarity of Purpose
There are at least three separate purposes that businesses could have for a budget. These include controlling costs, delivering on a plan and raising performance. By thinking they can do all three, they're more likely to do none of these particularly well.
This is not to say the processes and tools don't have value. They do. But businesses aren't using them correctly. Jack and Suzi Welch recently discussed this in the context of Sales incentives leading to overly conservative targets with no real ownership or trust.
Who really owns your budget?
Even the seemingly simple question of who owns the budget doesn't have a clear answer. I know plenty of CEO's who don't feel ownership, despite the fact that they are accountable for the delivery of the financial performance of the organisation. In large corporates most divisional heads would point to the CFO and the finance function. Certainly the timetable of setting a budget may be, but more often than not its for the benefit of the finance function, not the business. These timetables have no bearing on the decision making requirements of the business.
But how about the other stakeholders who influence and are affected by a business's financial performance? What do they need?
For medium-sized businesses, a bank may be a key stakeholder, as this provides some comfort especially in the Australian tick-boxing banking culture. Businesses that are subsidiaries of larger companies focus on profit and loss statements to keep the central financial team happy. It's "comfort", not decisions, these guys are after.
When we look at deploying the plan into the rest of the business, often the primary tool is the budget. How much effort goes into not only item by item budgeting but also tracking these items each month? A fellow TEC Chair, Barry Upfold, is always reminding members that the one budget line all companies are good at meeting is the expenses line, notwithstanding what the revenue line is doing.
Beware the Five Contradictions!
1. Precision over timeliness
How often have we had to wait for the results because the numbers aren't in? The precision required should be defined by the owner, not by the accountant. In 2016 there is no excuse not to know within hours of the end of a period how the business is tracking. The purpose is to inform and to frame the conversation, which then leads to decisions.
2. Reconciliation over performance
Double-Entry book-keeping was never designed to help run a business. It is brilliant as a control of mis-allocation and fraud and is embedded in the training of professional accountants. But it doesn't inform performance. It doesn't inform progress. Broad brush variance reports can ignore small item reconciliation without losing sense. The purpose is to inform and to frame the conversation, which then leads to decisions.
3. Review over foresight
Many people use a budget as a control. But a control against what? A frantic ”Finger in the air” guessing game conducted in the six weeks prior to the new Financial Year? It's a actually a poor tool for controlling actions and spending. This is mainly because it is used for review; Lag indicators of course can show trends, but other sources of information are better indicators of the future.The purpose is to inform and to frame the conversation, which then leads to decisions.
4. Compliance over strategy
Here in Australia we have plenty of compliance obligations. We like our rules. Tax compliance, employment regulations, company obligations specific to industries all need to be monitored. Some of these need regular updates but most just need a periodic overview. The risk is a focus on this compliance rather than on responding to external factors that change often on a weekly, monthly or quarterly basis. The purpose is to inform and to frame the conversation, which then leads to decisions.
5. Adherence over Response
Often the budget is the main tool keeping alignment to a plan or strategy. Just as most five year strategy plans can be criticised as being too rigid, even an annual plan is become less fit for purpose in many industries. In VUCA world, the merits of an annual plan are questionable and can be downright dangerous. An inbuilt agility is increasingly essential for survival.The purpose is to inform and to frame the conversation, which then leads to decisions.
The purpose is to inform and to frame the conversation, which then leads to decisions.
Businesses need to narrow down the purpose of their budgets, aiming for clarity rather than a scattergun approach. These processes are often wasteful enough without bloating it further by trying to achieve too many objectives.
We still need financial controls. We still need compliance and audits. We just need to separate these from trying to drive performance of the business.
A focus on Accountability
Accountability should not be just about sticking to a plan but maximising performance. This informs the conversation and the decisions arising. So we are designing a conversation and decision making framework, not a set of reports.
Key Elements in design
1. Create an ongoing process rather than a once off.
Too many organisations start their new financial year at zero. Why? was there some miraculous transformation in the market at the end of the last financial year? Nick Setchell, one of TEC and Vistage's best speakers encourages businesses to look at trailing 12 month results. This overcomes seasonal cycles, smooths out 4 and 5 week months and generally brings the focus on more strategic issues and underlying trends. Once that is mastered look forward and do a rolling 12 month forecast ahead; Once mastered it is no extra effort and a lot less disruptive than the usual budgeting hiatus. If this seems too hard, then start off on a quarterly basis and reset the priorities each quarter.
2. Performance measures focused more on lead indicators.
What drives revenues? How do you monitor these? What drives a gross margin? Utilisation? Delivery in full? These operational measures are the levers that drive the financial performance. Drive looking forward, not using the rear view mirror. Some decisions may lead to more project oriented improvements; use milestone a progress monitoring as part of the same discussion.
3. Make the invisible, Visible
Many CEO's I know have mastered the art of looking through detailed financials. They carry that ability with pride after having spent several years effort. What they forget is that it isn't just them who needs to understand the key numbers, its everyone else. Use graphs, trendlines, trailing averages, pictures. Visual management is the key to an engaged conversation, where every one not only receives the same information but shares it in real time. Less politics, more transparency, quicker action.
Just as many operations have workplace boards, start with a visual management board at the top of the organisation.
4. Remember, Cash is King
For most businesses, financial reporting focuses firstly on the Profit and Loss statement, less on the balance sheet, considered by some business owners as something to focus on at year end. But for most businesses the working capital movements are critical; in fact in the short term can make the difference between whether a business survives or not. The saying "Revenues are vanity, Profit is sanity and Cash is reality" has been borne out over the centuries. Cash flow forecasting is often a lot tougher than forecasting profit. Many organisations choose not to cascade cashflow drivers down into the organisation; they get what they deserve.
I'd be interested to hear of others' experiences and journeys and if you have other suggestions to the basic elements I've outlined here.