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“A spirited mind never stops within itself; it is always aspiring and going beyond its strength.”
Michel de Montaigne, French Renaissance Philosopher & Writer

 

As finance holds the reins of the 2017 financial plan process, having a great deal of influence how the plan activities are presented and executed, it might be a good idea to loosen up.  Right now your firm could use your spirited personality, interacting with managers and leaders during this financial plan cycle. This plan can be expected to be far tougher than in prior years. Even frightening.

 

Do your planning teams a favor & try challenging the teams to a pumpkin-carving contest, with no rules other than selecting from large pumpkin your finance department will provide. Keeping the teams loose, while strengthening team cohesion will be vital, as we may be involved in some of the most significant swings in possible plan scenarios in 2017.  We may need a gritty employee & leadership population to persevere some possible dramatic economic shifts here and abroad.

 

Warning: Watch Out for Financial Plan Funeral Marches or Dirges

Uncertainty seems to be an undercurrent in today’s business climate, with as many as 87% of 122 CFO’s responding to the recent Deloitte CFO Signals survey indicating that our nation’s presidential elections affected their economic future. The Association of Finance Professionals also reported in July that American companies were hoarding cash at higher levels during the second quarter, given Brexit concerns and “continued sluggishness in the global economy”.

 

The US is closing in on $20 trillion in national debt without abatement, currently representing nearly 80% of our nation’s GDP. Meanwhile, the prospect of interest rates hikes is plausible, which can crowd out private investment. If we want to stave off corporate funerals, we better entertain creative ways to conduct our business. Let’s put a premium on skillful resource handling and passing to winning opportunities.  The Golden State Warriors demonstrated their ability to keep their competition off balance. We can too.

 

Where Can Well-Grounded Optimism Be Found?

To paraphrase a VP of Marketing & Sales I had the pleasure of supporting at a semiconductor firm earlier in my career, ‘The good news about the plan is that it hasn’t happened yet’.  Regardless of what our plans have in store for us, or contingencies being set in place for any global downturn in the market, we still have time to prepare. This includes developing financial plans not only for revenue, profit and cashflow downsides, but for upside opportunities as well, targeting specific product lines, industries, or geographies.

 

Negative Thinking To The Rescue

Wouldn’t it be far more comfortable for us to shape our destiny—however difficult it may be, in real time, rather than to follow a static, unrealistic financial plan off into oblivion? Here’s where we can turn to sports and the disciplined approach of Bob Knight—the basketball coach having the #2 all-time NCAA Division 1 college record of wins, 3 NCAA Championships and lead the 1984 US Olympic Basketball Team to a gold medal as their coach.

 

Bob Knight in writing the book, “The Power of Negative Thinking”, shares an approach used throughout his career, as he prepared his team to confront each opponent, whether they were rated above or below his team. “…Losing is a potential reality you’d better be thinking about—in a season, or in a game, any game, just as a banker or broker had better be thinking about downside risk in any investment.” Building a strategy to find and exploit weaknesses in a competitor, while leveraging the strengths of his team was how he attributed his incredible success in achieving 902 college game wins.

 

Two Negative Thinking Takeaways

#1 is to know our ranked business strategic objectives. Is it to gain three points in global market share within our industry? Release product x, y & z during quarters 1, 3 & 4? Reduce our employee turnover by 50%?  Increase cash holdings to cover a quarterly sales cliff drop? We need to share whatever our firm’s overriding objectives are through the entire organization, prior to generating any detailed financial budget or forecast, tasked with meeting those objectives.

 

#2 is to know how in pursuit of our strategic objectives, our firm will work through a set of probable 2017 financial projections and the consequences they will have (using sensitivity analysis) to revenue, profit and cash flow dependent variables. The presidential election and any changes to what party controls the House & Senate will have a bearing on how independent finance variables will behave, including interest rates, corporate & individual tax rates, taxable employee benefits, medical insurance premiums, foreign exchange rates and possible changes to industry regulations and repatriation tax, along with prevailing government contractor and minimum wage laws and trade agreements.

 

Digging Our Own Graves or Fixing Budgeting Shortcomings

Most businesses operate under a fixed budget environment, comfortable with slight inaccuracies in assumptions that can be readily explained and which do not alter the integrity of the overall financial plan. Variance analysis of actual to budget can explain away any appreciable changes, leaving managers to continue to operate against their assigned departmental, area, functional, division, or corporate-wide budgets.

 

Problems with fixed budgets become more apparent when a series of budget anomalies appear, having an appreciable and negative alteration to overall revenue and having spikes in expenses that metastasize throughout the entire company. Under these circumstances, the budget is no longer able to offer proper guidance for managing the company. What’s our game plan when or if this happens?

 

The typical work-around for a dysfunctional budget, is to either a) perform a re-budget exercise; b) shift focus to performing ongoing detailed forecasts; or c) hold captive at a centralized level with direct management of staffing, capital acquisitions, and purchase requisitions over a given threshold. In any of these instances, management is distracted from effectively operating the business. Instead, they are preoccupied with cost containment while having lost flexibility in using resources, as leadership teams traditionally elect to centralize many resource decisions.

 

As effective resource allocations are undermined by expedient cost control measures, it becomes considerably more difficult to allocate resources differently between successful and unsuccessful business and functional segments. A company can in this instance flounder, exposing itself to lost market share by more nimble foreign and domestic competitors.

 

Consider Budgeting Alternatives

There are many ways to skin a cat. So too is the case with budgeting. Keep in mind that by keeping decision-making largely decentralized, while conveying any general swings to the business climate to the entire management and employee community can help the entire company react faster to change.

 

Think of the Apollo 13 mission mid-way on its trip to the moon. Following an explosion, the service module was seen leaking an unknown gas, while the command module instrumentation to the astronauts showed both a reduction in battery power and oxygen levels. There was no time for armchair discussions and a re-writing of the mission. The astronauts without prompting activated the LEM (designed for the lunar descent & return) life support system, to provide oxygen for all three crewmembers, while also shutting down all non-essential instrumentation to the command module. These activities took place within minutes following the explosion. Through these heroic efforts, the crew survived their return voyage to Earth.

 

New Measures Needed Beyond Executive Dashboard

What we really need is a financial signal system that can sound off alarms and activate management pre-planned drills (not dissimilar to NFL play calls) to combat high probability changing conditions, allowing time for the firm’s leadership and managers at all levels to consider the extent of damage to the general health of the company; how it can affect cash flow in particular; as well as ongoing or pending initiatives and programs (e.g. mergers & acquisitions, new retail outlet expansion, facility openings, renovations, or closures, along with research and new product development).

 

Dynamic Financial Planning

Kenneth Merchant, Professor of Accounting at USC recommended that we invest in a more adaptive approach that can immediately adjust management budgets whenever there are material changes to independent variables, such as interest rates & oil prices, while also being sensitive to changes in the competitive landscape. Professor Merchant also stressed the need for firms to trust their management team, keeping decision-making decentralized. Further, he advocated mechanisms for additional funds to be appropriated to managers outside of the budget, based on project merit.

 

What remains to be described in the public media by Prof. Merchant is how to implement the adaptive approach. What can be expected is a form of budget amendment authorizations and tracking.

 

Zero-Based Budgeting

Traditional annual budgets have an underlying implicit assumption that existing departments, functional groups, in-house services and product lines need to exist. Zero-Based Budgeting, managed properly, makes no such assumption. The entire company’s operation (or segment undergoing a Zero-Based Budgeting exercise) is up for review and budgets are assigned to operational elements based on their needed contribution (i.e. performance enhancement) to the firm. Irrelevant is any budget assigned in prior years to any program or service.

 

Zero-Based Budgeting invites many questions, such as, “Is it more cost effective to perform certain services in-house, or to contract the work out?” or “What quality of service is to be provided by Information Services to its user constituents and how is it to be measured?” This inquisitive introspection of the business is an exercise that is required without any reservation and complete support from a firm’s executive and management team. Sacred cows can be expected to come under intense scrutiny, allowing new business processes to be created, throwing off self-imposed, non-productive, time-consuming and costly constraints. Even if you aren’t employing Zero-Based Budgeting, start identifying your firm’s sacred cows now.

 

An introductory Zero-Based Budgeting effort would be expected to take more time than a traditional budget cycle, as an entire new way of thinking is involved in appraising the business. Cost centers don’t exist for cost collections sake; service centers exist with costs justified to perform essential, valued, measurable services, captured within accounts and departments.

 

The ideal end result of Zero-Based Budgeting is that a firm can better appreciate services essential to its operation; understand and  better manage cost drivers associated with vital service offerings; and be in a knowledgeable position to shed non-productive services and expense.

 

The downside to Zero-Based Budgeting is that we are still left with a fixed budget.

 

We can remember 2009 as a year with a sinking feeling across nearly all industries and across the world. Given the economic upheaval, PwC even released a publication in October 2010 titled, “Breaking The Cycle: The Case for Eliminating the Budget”. But did we learn much through that devastating year to alter our annual budget fix? Will our 2017 budgets leave us in a similar situation?

 

Bjarte Bogsnes’ second revised release this year of “Implementing Beyond Budgeting” comes at a fortuitous time, providing case studies of how two firms successfully grappled with replacing annual budgets with hybrid, ongoing multi-quarter rolling forecast models, coupled with building Activity Based Cost (ABC) drivers and balanced scorecards. The logic behind this approach is that:

 

  • There always is an ongoing view of the future; it doesn’t drop off at the annual financial plan’s fiscal year end
  • There is a focus on understanding the underlying cost behind activities (e.g. trade shows, business trips; new products under development), while inviting a discussion on an activity’s relevance, value & timing to fulfilling company strategic objectives
  • Setting Key Performance Indicators (KPI’s) that have the company’s over-arching strategic objectives in mind contribute to the entire company working together with common ends. There are non-financial KPI’s that drive financial results (e.g. employee turnover, employee & customer health, safety & security incidents, new product x release date, customer product returns, website security & downtime, time to convert customer prospects to customers), as well as financial KPI’s (e.g. Return on Assets Employed, A/R Days Sales Outstanding)

 

More on KPI’s

KPI targets with clear ownership are designed around SMARTER principles that are specific, measurable, achievable, relevant, time-bound, ethical and reasonable, with some being evergreen (remaining for extended periods of time), while others are expected to change, or be discarded for more relevant targets.

 

Downside to Bogsnes’ Approach & Partial Implementations

Many companies using conventional financial planning practices will not be able to readily convert in whole or in part to Bogsnes’ ongoing planning approach. There are fundamental changes required involving empowerment of employees and managers, as well as acceptance from key stakeholders and the investment community. The addition of KPI’s, while retaining conventional budgets is considered as a poor stepchild; retaining budgets as one measure of management performance is removed in the Bogsnes’ model, as it fails to measure constructive responsiveness to changing business conditions.

 

Closing Thoughts

We need to remind ourselves that 2017 hasn’t happened yet; we still have time for preparing our firm for a highly uncertain year.  There are a number of plausible scenarios how the New Year will play out, some of which might be frightening. While we consider how best to act, in all likelihood many of our annual financial plans are in the mill, crunching out new numbers as we receive new management inputs. Discarding or changing our financial plan process mid-stream while possible is not highly probable. However, it’s worth having a frank discussion with our leadership on how we’d like as a company to approach a financial re-appraisal, in the event that our budget can no longer represent our future.  Preparation for this possibility eliminates a knee-jerk reaction that can be detrimental to riding out any financial storm.

 

Charles Handy, a visiting professor of the London Business School delivered the Michael Shanks Memorial Lecture in 1990, closing with the following words, which are appropriate for the circumstance we find ourselves and our firms:  “… in a time of change we must always question whether the things that used to work will work so well in the future. We must not be slaves to our history but trustees of our destinies. Our businesses are too precious to be lost because we have not dared to question the past, or to dream of the future. Let us start now, before it is too late.”

 

Eliminate the Annual Budget

Why preserve the annual budget? A strong case can be made to eliminate the annual financial plan altogether.  Business Finance revealed that 28% of executives found their 2009 budgets obsolete before the year began & two-thirds found their budget obsolete by mid-year.

Kenneth Fick

President, CEO of FPAexperts.com and Senior Manager at MorganFranklin Consulting, Inc, Mr. Fick is senior finance leader that brings ideas from concept to execution. A frequent speaker and author on topics such as budgeting, forecasting planning, technical accounting, business improvement, and optimization.

1 Comment

  1. Den February 19, 2018

    Hi,
    Thanks! Good stuff about Financial plan cycle.

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