NO MORE FREE RIDES
The result: an
always-current financial forecast that reflects
not only the company’s most recent monthly results
but also any material changes to its business
outlook or the economy. In addition, it provides
fewer opportunities for account directors to ride
the coattails of past performance. “Now,
even the guy who booked a million dollars’ worth
of business in one month can’t sit still because
30 days later, we’re going to have an entirely new
forecast,” Payne says, adding, “It’s a dynamic
process that makes a lot more sense.”
Although traditional one-year budgets are still
the norm at most companies large and small, many
accountants argue that rolling budgets can be a
far more useful tool. Unlike static budgets, they
encourage managers to react more quickly to
changing economic developments or business
conditions. They discourage what is too often a
fruitless focus on the past (“Why didn’t we meet
our numbers?”) in favor of a realistic focus on
the future. And they produce forecasts that, over
the near term, are never more than a few months
old, even when companies are rolling them forward
on a quarterly basis—the more common
approach—rather than REL’s monthly basis.
“A static budget simply doesn’t reflect the
pace of business today,” says Jill Langerman, CPA,
president and CFO of the accounting firm Fair,
Anderson & Langerman in Las Vegas. “If at
midyear you add a new product to your lineup, you
want to calculate the costs and profit margins
associated with that and reflect those
calculations in your budget. If you’re evaluating
your product lines and decide to eliminate one,
you want your budget to reflect the impact that it
will have on your remaining product lines. That
way, you can set an accurate performance target
and make informed decisions about whether you’re
now free to invest more in the remaining product
lines or perhaps add a new line. If you’re not
incorporating these new analyses into your budget,
it becomes a rather useless document.”
Implementing rolling budgets doesn’t
necessarily require any fundamental change in the
way a company has been doing its budgets—except,
of course, it no longer does the job just once a
year. However, companies that decide to step up to
rolling budgets may want to take advantage of the
decision to make a change and consider what else
they can do to improve the process. After all, if
a company can get everyone on board to make such a
fundamental change, a further nudge to make the
process more effective and efficient in other ways
may be possible, too.
THE PROBLEM OF RELEVANCE
In the view of
many accountants, traditional budgets too often
are useless because they are out of date soon
after they are assembled. Assuming that much of
the decision making that goes into them gets done
in the fourth quarter of the prior year, by the
end of the following year, traditional budgets
reflect thinking and data more than 12 months old.
Not surprisingly, such documents tend to get short
shrift from front-line managers. In worst-case
scenarios, they can even promote behaviors and
business decisions that are counterproductive.
Consider the real-world example of a
Fortune 500 company that has been
talking with REL about how it might improve its
forecasting to produce better financial results.
The company uses a traditional static annual
budgeting process in which it sets monthly sales
goals for each of its products. If the company
misses its sales targets in the first month,
product managers will typically push those
projected sales into the final quarter of the
year. By doing that, corporate management is
acting as if the outlook for the full year remains
unchanged even though sales were off to a slow
start. But if the slow pace continues and
product managers begin to realize that their lost
sales can’t be made up in the last quarter, they
start to budget them out over all of the remaining
quarters of the year. Frequently, they wind up
running massive discounting programs at the end of
each quarter to hit their annual targets.
Fortunately, the company can afford such budget
maneuvering because it enjoys relatively high
margins on its products, but such manipulation
isn’t maximizing its return on investment.
ACTING RATIONALLY
“The static
budget encourages managers to create artificial
demand for their products, not end-user demand,”
observes Payne. In other words, the company stuffs
its distribution channel and simply delays future
shipments. If the company had a more realistic
budget, product managers would be able to act more
rationally, eliminating the last-minute forced
discounts. In addition, says Payne, with a
better picture of what they were going to sell,
they could make better investment decisions.
“Maybe a product manager would decide not to spend
another $6 million on a new packaging line, for
example, if he knows he’s not going to sell the 20
million units he thought he was going to sell. You
take the gamesmanship out of the organization.”
Not only are static annual budgets
restrictive, it turns out that many managers don’t
really like them. “Most of our clients complain
that their current planning process is extremely
painful and time-consuming,” says Anne Swaller,
general manager of the Stanford, Connecticut,
office of Parson Group, a national consulting firm
focused on finance, accounting and business
systems. Assuming the client is operating on a
calendar year, Swaller adds, everyone runs around
feverishly in October and November to do
budgeting, and then at the end of the process,
they’re happy to get it over with—knowing they
don’t have to do it again until the next November.
Unfortunately, those same managers often
have their compensation tied to the budget, which
lends it import even when it’s no longer accurate.
“If I’m a manager responsible for meeting my
monthly numbers,” Swaller says, “I’m going to
spend a lot of nonvalue-added time to ensure those
numbers are met, even if it means shipping [extra]
product at month’s end.” “It becomes a
merry old dance,” agrees Payne, who recalls doing
work for a British manufacturer that routinely
shipped extra product at the end of each year to
meet sales targets and then sold only spare parts
in January and February. The trouble is, once you
start that process, you have to keep the charade
going year after year, Payne explains. “What this
company really needs is a new CEO to come in and
say, ‘I’m not going to do this anymore.’ But
anybody who does will realize that they will have
to take a big hit to sales and earnings in that
first year, and that is quite a lot for anybody to
take on.”
MANAGE THE INFORMATION
Implementing a
rolling budget involves more than going through
the annual budgeting process four times a year
instead of one. Because the time between budgets
has been compressed, management must access and
process information more quickly than it was able
to do in the past. To do that, line managers must
become more involved in the process and the
company must embrace technology that will allow it
to quickly capture and disseminate the raw data
needed for decision making and forecasting.
Most organizations today rely on Microsoft
Excel spreadsheets to do their budgeting. They
work, but they can be laborious, requiring finance
managers to piece together input from all the
operations managers throughout the organization.
“We were called in recently by an insurance
company that was using huge, linked spreadsheets
to do all of its budgeting and planning,” recalls
Swaller. The process was slow and exhausting,
producing a static and reactive product that was
built on data that was typically at least six
months old. Today, that company uses a
specially designed budget planning, forecasting
and analysis software product to do the job. (For
a list of such software, see the sidebar
“Software for Budget Planning and Analysis.”
) This kind of software makes it easier for
managers throughout a company to access, enter and
share data on a real-time basis, using the
Internet as a communications medium. “This
company now has the ability to react quickly to
changes,” Swaller says. “Also, its budgeting
process is no longer a push from the top down.
It’s become a process that involves everybody from
the senior level of management to the line
managers, who now have a commitment to the process
that they never had before.” Managers used
to spend a lot of time allocating expenses among
different segments of the business. Since the new
software automates the process, managers can spend
more time analyzing the data.
THE BIG PICTURE
“This is how
technology makes a difference—by gathering
real-time information from all over and putting it
into a central resource,” Payne explains. It gives
top management an overview of what’s happening on
a local level—even if an enterprise operates
worldwide. For public companies, the
benefits of more timely and accurate budgets may
ultimately extend beyond operations. Under Wall
Street’s close scrutiny, meeting earnings
forecasts has become more important than ever. A
misstep, even one that’s just a penny per share
below expectations, can translate into a sharp
stock sell-off and, in the long run, drive up a
company’s cost of capital. “Theoretically,
between rolling budgets and predictive accounting,
companies can minimize the controllable factors
that cause inaccurate earnings projections,” says
Swaller. “Therefore, they would have fewer
actual-to-forecast variations, which in turn would
help cut down on stock price volatility.”
Although no budgeting technique can predict the
future, these techniques allow companies to get
much closer to the ideal. The only holdback is the
willingness of a company’s managers to use these
new technology tools that are now available. |