Planning & Forecasting

Now that we have spent some time discussing several problems with traditional budgeting, let’s look at some alternate approaches. Here is a review of the first three problems from my prior blog:

• Time Consuming and Costly
• Quickly Irrelevant and Outdated
• Financial Process Largely Disconnected from Specific Drivers

The biggest problem to me is the overall value (or lack thereof) that a traditional budgeting process provides the organization. The concept is sound. The execution is where the opportunity lies.

One of the first steps is to determine the correct level at which to forecast. I’m referring to the number of accounts and entities (cost centers, profit centers, store fronts, functional areas, etc) you choose to budget. We often believe that more is more. In my experience, that is not true at all. Less is more. More detail means more time, not necessarily a better plan. There will always be puts and takes in your numbers as the year progresses and you compare actuals to budget. But if you build a very granular plan at the beginning, I have found that you end up with more misses. This is due to the budget review process where it is easy to look at the numbers through rose colored lenses. “The powers that be” make you bring every account or entity that is worse than prior year back to PY levels while keeping the goodness already baked in to other locations and accounts. You rarely get the offset so you end up with an unrealistic plan since we only take away one side of the equation.

Plan at the lowest level required for operational planning so you can get people, product, and capital in the right places at the right quantities. Your plan needs to be strategic in nature and should provide enough detail to allow for downstream capital planning. Don’t waste your time getting caught up in the weeds because the value add is simply to low. You must strike the right balance between detail and value to the company. As you spend time collecting numbers and assumptions for a given item, always ask yourself whether it provides actionable intelligence that will help you make meaningful decisions that drive the business forward.

As we learned in a prior blog, almost 50% of respondents stated that their business plan was outdated 1-3 months into the plan year. Wow!  Many of us spend several months on our plans only to have them become useless shortly after they are finalized. They become a variance column on our monthly reporting and then we just use it to see if we are on track for our bonus or not. If we agree that a business plan can still add value (which I do), then we need to find ways to shorten the amount of time it takes to complete.

One way that has multiple benefits is to make your budget driver-focused. Not only will this make the update process quicker, but it will help you connect your budget across all functions in your company. You need to ensure that your budget does not become a simple numbers game by aligning with operations, marketing, IT and others to build linkages throughout the organization, understand their needs for the upcoming year and create a shared vision that you are all marching towards. Choose the Key Performance Indicators (KPIs) that drive your industry and incorporate those into your planning process so you can quickly update your revenues and expenses. In my FP&A days, I focused on Rate per Day, Rate per Transaction, # of Transactions, # of Days, Transactions Per Employee, Average # of Vehicles, % of Revenue, etc. Armed with these assumptions, you can quickly update your budget when the need arises. Use these drivers to plan variable costs and then utilize a simple inflation factor to plan for your fixed costs. Here is a basic construct I have used successfully for many years:

(Rate * Driver) + Increment

The first part is clear. The increment is important because it provides the ability to plan for one-time items without having to artificially alter a rate to back in to the number. Without an increment or adjustment account, we lose the power of iteration as we can no longer simply update the driver because each rate needs to be reviewed as well to normalize it again for your starting point. Let’s say I have a particular expense that typically runs $100 (rate) per widget (driver). But I know that next month I have a one-time expense of $250 (increment). Using the above formula, I can easily increase my account by $250 to incorporate the one-time items. You can also use this to make last minute adjustments to your rate driven accounts without creating unrealistic rates.

While there are many changes you can make today that can help you avoid these pitfalls, we only had time to discuss a few here. We will look at a few more strategies in my next blog. As always, if you have some ideas to share or want to discuss further, please reach out.

Read more blog posts in Brian’s FP&A Done Right series:

FP&A Done Right: There is Life After December – The Fixed Forecast Dilemma

FP&A Done Right: Beware of Budgeting, Part I

FP&A Done Right: Beware of Budgeting, Part II

How is your budget/budget prep coming along? Have you set aside time to rethink your process? In that last installment of FP&A Done Right, we started our enumeration of the problems with traditional budgeting. Before I discuss several more, here is a reminder of the last few problems:

• Time consuming and costly
• Quickly irrelevant and outdated
• Financial process largely disconnected from specific drivers

Let me highlight more now and then we will move towards some alternative approaches.

Principled upon negotiating/gamesmanship

I can still remember my first visit to Corporate to review (or as I soon learned, to defend) our annual budget. Back then, I was fresh off my MBA and I had landed a job at one of our Region offices. We had just spent months building a plan from the lowest level, capturing input and feedback from every location manager and painstakingly describing every variance to the penny. We were ready. This was a done deal. Boy was I naïve. We were escorted into a nice room with a large table. Around the table I could see the president of our division and the heads of every major functional area ready to discuss our plan. Game on! My controller and I didn’t even get a chance to pull out most of the backup schedules we had created. He spent his time trying to negotiate fewer expense reductions and less revenue while I was busy taking notes on all the “savings” and “initiatives” the team had just found for us during the review. Great news. Thanks for the assist. I learned my lesson that day. After that, I knew that I had to pad my expenses and sandbag my revenue. They knew we did it too which is why they had us take a 5-10% cut in expenses as soon as we walked in the door. That is a difficult game to stop playing and, in the end, no one wins. Yet, many of us continue to play.

Triggers Unnecessary Spending

Since our budget numbers are frequently tied to prior year spend rather than being based on needs (a zero-based budgeting approach), we feel the need to spend money just so we have the same amount available to us next year. This is crazy, but I still see it today. We should be creating an environment where our front-line managers are rewarded for being fiscally conservative, not penalized. If you find a way to save money this year, we should be analyzing what you did so we can replicate it with your peers rather than giving you a hard time next year since you now have a large YoY increase.

Creates an inflexible performance contract

This is a big one as it impacts your managers directly in their bank accounts. This is especially true when incentives are tied to performance against the annual business plan. Once my budget was completed, I knew I would spend the rest of the year running actuals vs budget reports so we could determine what our bonus would be. If you remember from the first part of this blog, almost two-thirds of budgets are outdated between 4-6 months into the plan. If that’s the case, why are we using that number to determine the bonus for our managers? I want to reward my managers for changing course if they see something that is in the way of them achieving their goals. Compensate them based on what is occurring now, not what you thought was going to happen 12 months ago. When we focus on an inflexible budget number, we begin to manage to that number.  Don’t fall in to that trap.

Drives Wrong Behavior

It doesn’t take long before you know roughly where the year will pan out vs the budget. You know fairly quickly whether it is attainable or a long shot.  Since compensation is tied to the budget, it tends to drive the wrong behavior. You should expect your managers to do what is in their best interest. It is your job to ensure that by doing so, the company gains as well. If I am in the back half of the year and I already know I can’t achieve my annual budget numbers, where is the incentive for me to continue to find cost savings and improve my processes. I might as well give up on trying to get better this year because I won’t reach my bonus threshold anyway.  Right? Maybe I’ll push off a cost savings initiative until next year.  Or I’ll try that new revenue generating idea at the start of next year. The same is true if you have already maxed your bonus for the year. Why continue to do better? Save some of that goodness for next year. You need to make sure that the company goals are aligned with the individual goals. A budget can create a false sense of security and it may be holding the organization back from achieving its true potential.

It’s often easier to ‘see’ a problem when someone else describes it. My hope is that while reading this, you took some time to compare and contrast these issues with your methodology and approach to the budget. Does anything look familiar to you? If so, perhaps it is time to make a change.  Please reach out and share your stories with me. In my next blog, we’ll discuss some alternatives to these problems that you can begin using immediately.  Happy budgeting!

Read more posts in Brian’s FP&A Done Right Series:

FP&A Done Right: Beware of Budgeting, Part I

FP&A Done Right: The Importance of Including FP&A Often and Early in Your Strategic Planning Process

FP&A Done Right: 5 Signs it’s Time to Rethink Your Process