For the last 20 years, I have focused on designing, developing and implementing world-class finance, process and technology solutions for clients ranging from Mom & Pop Start-ups to Fortune 500 corporations. What I have recognized during this time is that regardless of the organizations size and focus, issues and opportunities seem to be pretty consistent. This blog focuses on the good, the bad, and the ugly of what our clients face on a day to day basis.
GOING FOR ZERO (BASED BUDGETING THAT IS)!
Ah, the planning season is upon us! I can just sense all of the excel spreadsheets being developed, transmitted, updated, returned, consolidated, reviewed, and adjusted!!! It is the annual tug of war played out at most organizations around the world (albeit the start time and duration of the planning season will depend upon your fiscal calendar as well as the size and complexity of your organization).
Many organizations will use the tried and true “run-rate” methodology to support their annual planning process. In a nutshell, this run-rate methodology consists of the following:
- Headquarters develops some high-level planning assumptions (e.g. at a very high level: sales growth factors, cost of sales factors, sales allowance factors, headcount run-rate, salary increases, other operating expense factors, capital purchases, cost of capital assumptions, and effective tax rates).
- Headquarters uses these high-level planning assumptions to develop both company and divisional operating targets.
- Headquarters distributes these targets to field personnel and asks for a budget submission to be returned hitting these pre-defined targets.
- Field personnel typically pull their budgets together and come up with a much different number than the target they received.
- Field personnel think about how best to justify not hitting their targets, tweak the numbers a bit and submit them.
- Headquarters receives the bloated budgets and arbitrarily cuts them at a line level to get back to the original target communicated.
- Though it is published, no one takes ownership of the final budget that is loaded to the general ledger for reporting purposes.
While it is an easy form of planning, this run-rate method leaves a lot to be desired. There are typically business events that take place during the year that skew an organizations run-rate. While the field staff is aware of these, headquarters may not have visibility into these fluctuations and may set and artificially high (or low) target as a result. Field personnel will leverage this to their advantage accepting a net income target that may be too low (in hopes of exceeding it and being compensated in a significant manner) or rejecting a target that is too high by explaining the details of the issues with the run-rate used to set the target.
OK, so we have no hope of establishing a meaningful target that is understood and accepted by both headquarters and the field? Not so fast. You may want to consider migrating from a run-rate to a zero based budgeting basis. While zero based budgeting requires a more detailed involvement from the field, it is an environment based upon establishing the value of every dollar spent. It fosters a healthy discussion of, “just because you needed 10 people / contract staff last year, why do you need 10 people / contract staff this year?” If deployed properly, it establishes a detailed cause and effect relationship between an organization’s sales / revenue volumes and the people / technology resources required to support those sales / revenue volumes. If a field manager can not justify the spending of specific dollars, then maybe it should not be spent!
In a nutshell, if your organization is four levels deep (e.g. consolidated company, division, region, and department) and each level included a cushion or 1% on their run-rate, then you will end up with an expense budget that is at a minimum 4% too high. To make the point a little better, if your Selling, General & Administrative expenses (SG&A) were $10MM per year, you would have $400K in budget bloat. From my experience, this budget bloat will not be returned to headquarters, it will be spent!
So, when you think about it, committing to ZERO could have a pretty large positive impact to your organization’s bottom line!
OK, now make the commitment to challenge yourself to challenge your people! Go forth and be a ZERO (based budgeter that is)!
Mark T. Warren, MS
Director of Business Consulting
Gorfine, Schiller & Gardyn, PA
Mark Warren has over 20 years experience in business consulting, including business performance management, contract management and strategic sourcing. He works with clients of all sizes in Baltimore, Maryland and throughout the Mid-Atlantic.