FINANCIAL BUDGETING THAT MATTERS 8 TIPS FOR A BETTER BUDGET

Global Finance 360 | Copyright 2011 | All Rights Reserved 1

Global Finance 360

. Speak with virtually anyone involved with the annual budgeting process and they’ll tell you that it’s painful: time consuming, difficult, error prone, and based more on politics than on valid economic assumptions. The worst part, however, is that the budget is viewed as obsolete almost as soon as it’s complete. Despite these challenges, most corporations are tied to the traditional budgeting process as they don’t believe they have anything better to replace it with.

Fortunately there are companies who have scrapped the traditional notion of a budget and have replaced it with something much more useful. They still have a budget, but their updated budget has been streamlined. No longer do they put themselves through the long and difficult budgeting process; rather, they focus on creating a budget that is far less detailed but that communicates the key ideas of the planning process.

The Goals of Budgeting

The annual budget and the budgeting process serve a number of goals. Among them are:

� Link operational plans from multiple departments. The budgeting process, as opposed to the actual budget, fosters communication and enables the coordination of business unit and departmental activity across the organization to support the achievement of strategic plans.

� Capital allocation. One of the key aspects of the budget is to decide where a company will employ its resources. Strategic plans around new products and markets, research and development, production capacity and other dimensions will feed directly into the budget.

� Performance monitoring. The control of capital and the early detection of deviations from establish plans have also been key elements of budgeting. Reports comparing the variance of actual results from budget are a standard component of management reporting packages.

� Compensation rewards. Many executives have a portion of their pay linked to the attainment of budget goals. The targets established through the strategic planning process are incorporated into the budget and ultimately into the annual performance plan for these executives.

The Problem with Traditional Budgeting

Budgeting as a tool can be very useful but the traditional budget is a product of a distant past. During most of the 20th century, manufacturing dominated the industrial landscape. These businesses were hierarchical and capital intensive. It was the job of managers to oversee the deployment and allocation of capital. To do so, they needed strict controls over capital allocations and information to understand how closely they were tracking to their financial objectives during the year. Couple this with a business

” To achieve

maximum value,

managers will

need to reinvent

their budgeting

process to make it

more meaningful.

In leading

organizations, the

financial budget

represents the

culmination of an

effective process

that translates

strategic

objectives and

operational plans

into financial

plans.”

Author: Stephen G. Lynch

Global Finance 360 | Copyright 2011 | All Rights Reserved 2

About Global Finance 360

Global Finance 360 covers the world of corporate finance and accounting and how these activities are impacted by globalization. Focus areas include Finance Delivery Strategy, Shared Services, Business Process Outsourcing, Process Improvement and Organizational Design.

Global Finance 360 is run by Steve Lynch. Mr. Lynch is a Principal in the Finance Transformation practice of a global consulting company. He is responsible for the marketing, sales and delivery of Finance Transformation services in North America and serves as a key liaison for his company’s global Finance practice. He brings more than 15 years of experience advising global companies on their service delivery strategies and has served over 60 clients in a variety of industries including consumer products and industrial manufacturing, aerospace & defense, transportation, technology, entertainment and financial services. He has also served as a Controller in private industry and as an auditor in public accounting.

Mr. Lynch is an active content contributor on the topics of Finance Transformation and globalization and has presented at various forums including the IQPC Shared Services & Outsourcing conference. He can be found on the web at www.globalfinance360.com.

Contact Information:

Steve Lynch

Toll-free: +1.800.216.2512

Office: +1.719.481.2599 1042 W. Baptist Road Suite 194 Colorado Springs, CO 80921

slynch@globalfinance360.com www.globalfinance360.com

environment that was minimally impacted by globalization and it’s easy to see how a detailed, static budget was sufficient to provide value to management.

Unfortunately, while the world changed the annual planning cycle remained relatively static. Whereas in the past manufacturing facilities and production volumes helped determine corporate value, companies today are far more likely to create value through product innovation, mass customization and agile supply chains. Given the new realities, traditional budgeting suffers from the following issues:

� The traditional budget takes too long to prepare. It’s not uncommon for a budget to require 4 – 5 months and consume a substantial portion of executives’ time.

� The budget is too manual. Many companies prepare and consolidate their annual budget in Excel. This increases the time necessary to develop the budget and exposes the budgeting process to human error as spreadsheets are manually combined to reflect organizational roll-ups.

� The level of detail is too great. Many companies make the mistake of building too much detail into the budget. This creates far more complexity than is necessary. Instead of facilitating the budget process, it actually becomes a hindrance to the creation and monitoring of the budget.

� The number of iterations is too high. A typical budget can require 5 - 6 iterations before the numbers are accepted by senior management. Leading companies focus on minimizing the number of iterations to reduce the time and effort spent on budgeting.

� Budgets are internally focused. Most of the numbers in the budget are based on previous years’ data. All too rarely is a budget based on existing and anticipated economic factors that drive volume and cost. Few companies evaluate their proposed revenue and cost structure based on similar companies in the industry. Finally, the budget measures internal metrics such as revenue growth, but fails to take into account other levers of value such as customer satisfaction.

� Budgets lock in costs through the year. While the budget is thought of as a tool to control costs, all too often costs are locked into the budget for the year. Even if economic conditions vary widely from the assumptions upon which the budget was built, the company’s cost structure resists downward pressure as those costs were budgeted for the year.

� Politics permeates most budgets. The annual budgeting process has become a high-stakes game of bluffing. Many managers “pad” their budgets with extra costs so that they end up with something they envisioned after their budget requests have gone through multiple iterations.

� The budget is quickly obsolete. Given that the budgeting process can start four or more months before the end of the fiscal year, and coupled with a dynamic business environment, it’s no surprise that many budgets are obsolete after the first month of the fiscal year.

Building a Better Budget

Given the challenges in the budgeting process, leading companies have moved to a new budgeting paradigm that emphasizes speed and flexibility. Here are eight ideas to incorporate into the budgeting process:

Global Finance 360 | Copyright 2011 | All Rights Reserved 3

About Global Finance 360

Global Finance 360 covers the world of corporate finance and accounting and how these activities are impacted by globalization. Focus areas include Finance Delivery Strategy, Shared Services, Business Process Outsourcing, Process Improvement and Organizational Design.

Global Finance 360 is run by Steve Lynch. Mr. Lynch is a Principal in the Finance Transformation practice of a global consulting company. He is responsible for the marketing, sales and delivery of Finance Transformation services in North America and serves as a key liaison for his company’s global Finance practice. He brings more than 15 years of experience advising global companies on their service delivery strategies and has served over 60 clients in a variety of industries including consumer products and industrial manufacturing, aerospace & defense, transportation, technology, entertainment and financial services. He has also served as a Controller in private industry and as an auditor in public accounting.

Mr. Lynch is an active content contributor on the topics of Finance Transformation and globalization and has presented at various forums including the IQPC Shared Services & Outsourcing conference. He can be found on the web at www.globalfinance360.com.

Contact Information:

Steve Lynch

Toll-free: +1.800.216.2512

Office: +1.719.481.2599 1042 W. Baptist Road Suite 194 Colorado Springs, CO 80921

slynch@globalfinance360.com www.globalfinance360.com

� Establish key linkages between the strategic plan, the Sales & Operations Plan and the financial budget. The numbers in the financial budget should be the culmination of a planning process that begins with the strategic plan and incorporates demand and supply plans from Operations.

� Scale down the budget. Reduce the number of line items budgets to focus on the true drivers of revenue and cost. It isn’t necessary or desirable to create a highly detailed budget. Focus on key line items that are material and that are derived from supporting operational detail.

� Automate the budget with a dedicated software solution. Reduce reliance on Excel spreadsheets and manual consolidations. Invest in a dedicated software solution that provides a web-based interface for users, workflow, security and that automatically rolls up budgets at each level of the organization. These software packages also facilitate the reporting of actual, budget and forecast data.

� Employ zero-base budgeting. Don’t use last year’s numbers as a base for the upcoming year. It’s too easy for managers to simply resubmit their numbers without going through the exercise of determining costs based on estimated activity volume.

� Document budget assumptions (e.g. growth rates, estimated activity volume). Just as footnotes are an integral part of financial statements, the assumptions made to develop a budget are also critical. Assumptions must be realistic or the budget will lose credibility.

� Foster dialogue across functions. The process of budgeting, if done correctly, can add as much or more value as the budget itself. When departments work together on an integrated budget, they gain a better understanding of the challenges facing the overall organization. Strong communication leads to more useful budgets.

� Move compensation goals from a static budget to a series of balanced KPIs. Yes, some will still be financial in nature and a streamlined budget can capture those. Revenue, Gross Margin, EBIDTA, Return on Invested Capital can all be measured against pre-established targets. But managers should also be evaluated on non-financial factors such as product innovation, time-to-market, employee satisfaction, customer retention and customer satisfaction ratings.

� Allocate capital based on a dynamic forecast rather than on a static budget. In most industries business events occur too quickly to depend on a static budget for capital allocation. Leading companies use their forecast to identify emerging market opportunities and enable them to respond more quickly to those opportunities.

Conclusion

Budgeting still matters, but to obtain the greatest value from the budgeting process, companies need to adjust to the present realities. By following tips outlined above, companies will produce more meaningful budgets with less effort and cost, freeing up time and management attention to focus on creating value in their businesses.