It is late in the night, the lights in one section of the office are on (no prizes for guessing which function this is), the CFO and his team are busy with the year end closure, getting ready for audits and there is also a budget exercise looming ahead.Budgeting is an annual feature in every company’s itinerary and is quite an elaborate process if its done well. Most large organizations have robust processes and better quality talent to be able to pull this off with relative ease. The issue lies with mid corporate organizations who are neither too large to have the processes and people nor too small to ignore this, especially those who have an investor on board or where the accountability rests with the board. Having seen many such organizations, I have put together my thoughts on how can organizations get the best out of a budgeting exercise. This is in no way comprehensive nor do I claim to be a ‘guru’, this is purely experiential and has come from my exposure of having dealt with such companies.
1. Review and reset your standard costing:
Most of the mid-sized companies would have standard cost cards for their product or service lines. Year-end is a good time to dig deep into the records to re-validate the actual costs against the standards and thereby review the need to reset the standards, in line with the real/actual costs. The company may focus on historical costs but the golden rule is ‘Lets not forget to consider inflationary trends’.
2. Knowing your non-profitable business segments:
During the year we take decisions to enter new and opportunistic business segments. It is a good time to review these investment decisions particularly at the end of the financial year, when the performance reporting is assumed to be reasonably correct. Clearly knowing your profitable and non-profitable ventures, assists in taking ‘exit’ or ‘scale-up’ decisions.
3. Identifying your key risks and your plan to keep them in check:
It’s a fact that life does not always go as per plan. As they say, there is an element of risk even in crossing the road. Not only is a careful consideration of the underlying risks important, but having a common understanding and agreement over action plans for risk mitigation and allocating finance towards the mitigation is also equally necessary.
4. Knowing your sensitivities and What-if’s scenario’s:
All planning exercises are futuristic and assumption driven. Most investors and boards would like to understand the impact of variability in your key assumptions on your revenues, profitability and cash flow. My tip would be to select a minimum of three assumptions, and develop two more scenarios around them (one optimistic and one pessimistic), in addition to the normal (realistic) scenario to understand how the business model reacts to swings to external influencing factors. Higher the probability of positive swings, higher are the chances that your excel model might work in reality.
5. Plan for cash shortfall-months:
Most companies are very good in preparing a very detailed P&L budget, but usually ignore the cash flow angle. In my view, cash planning is equally important (if not more important) than profitability planning, for mid-sized companies, knowing most scale-ups are on the back on either consistent operating cash flow-burn or large capex investments. Knowing your periods of cash-shortfalls is important to pre-arrange funding lines, so as to avoid situations of cash-outs.If you are a seasonality-influenced business, importance of cash flow planning cannot be over-emphasized, so you can fill up your cash-chests to tide over temporary shortfalls.The oft used adage ‘Cash is King’ holds true in most businesses and in most situations still.
6. Monitoring your own progress:
Whilst most of us finance professionals invest days in creating a good quality plan, most are guilty of not following through to monitor the progress of the plan. I see the first step towards this as cascading your approved plan with your operating managers. Whilst they might have been involved in its creation in the first place, it is important for them to know the growth path the company has finally taken and their contribution towards the same. The second step could be in identifying key metrics that would assist in progress monitoring. A tip here, is to turn-back into your plan and use some planning assumptions as key metrics. Include these metrics as part of the Operating managers yearly KPI’s and incentivise them for achievement. Third step is setting processes to report progress on key metrics identified. Reporting could be either automated or manual reporting with pre-agreed frequency. In case the company does not yet have IT systems, my recommendation would be to start the manual reporting and then once settled, bring in/ improve the automation. Don’t wait for that perfect solution to get implemented, this will only delay things. Ensure that reporting happens religiously, so that the seriousness quotient is maintained. Don’t forget the old cliché “What doesn’t get measured doesn’t get done”.
The success or failure of a budgeting process is determined not just by the intent, a huge portion of the success depends on the organization culture, the enthusiasm of the operating and business teams and a smart CFO who is able to work with the existing systems, people and pull this off. This separates the wheat from the chaff, the good from the ‘Great’.