I reviewed another corporate budget last week and it reminded me how much I don’t like the activity. In my 40-year career I have probably reviewed, negotiated and approved 300+ budgets and have felt, in retrospect, like my teams wasted hours and hours of valuable time. I often ask companies what their philosophical accuracy of the percent of the budget they expect to achieve is, and I get answers from 75% to 100%. But never over 100%.
So, what is the real purpose of the budget?
Budgets DO NOT:
- Pay any bills
- Pay any bonuses
- Buy down any debt or provide any additional capital
- Add to stockholders’ equity
- Have much to do with the services you sell that clients want.
A budget is a ‘one point in time’ mental exercise that involves draining emotional interactions and often subordinate gaming for the lowest acceptable number. Management teams struggle with different techniques of bottom-up or top-down styles in repeated iterations to derive desired results.
So why do we spend so much time (and energy) on budgets and their iterations? Isn’t this really a topic where IBM’s Newton (or computer automation) could do well without much distraction, to leave you to lend your attention to more important company activities?
If I were to automate anyone’s budget, this is the analog I would give Newton: Start with the last year’s gross revenues and increase them by the sum of the growth rate of last year’s industry competitors plus additional 5 %-points. So, if your industry competitors grew by 4%, the top line revenue would increase 9%. Why? First, in a labor-based business, you should get +3- to 4%-point growth just from annual cost of living salary increases. The logic being this revenue level is level of revenues you have to grow to in order to move up or stay even on the league tables.
Then I would move to overhead.
I would tell Newton that the last year’s variable overhead costs (insurance, fringe benefits, office space, holidays/vacations) would be scheduled to increase at the revenue increase rate less 3%-point, or 6% in this case. Why? Because there are many economies of scale and some of the added new revenue growth comes from less tenured people who can fit into our palatial offices without expansion. The backroom administrative fixed labor overhead (executive, accounting, legal, procurement, executive) would grow at half of the revenue growth rate because I would expect efficiencies in this area and would want to bring some of my growth to the bottom line by consistently having a lower overhead.
I would not budget for acquisitions, separating them between completely organic growth and acquired revenue. I would put the newly acquired revenue into next year’s starting budget.
That’s it! The resultant calculated profit would mathematically appear. Newton is smart and I am sure it could calculate it in five seconds for the value the budget adds. No meetings—just issue it.
So, what are often-heard reasons to spend tremendous time interacting on budgets?
Some companies budget just because of operational tradition and what they perceive as good corporate hygiene. They have never thought about the value—it is just an annual event.
Some companies view the budgets as an initial forecast, but then as the year proceeds they stop using it as a forecast because budgets aren’t supposed to change to meet reality. Most companies use both a starting budget and periodic forecasts during the year. So, the value of the budget evaporates during the year. (That being said, I was in a joint venture with a European entity that insisted on re-budgeting three times during one year. When I asked why, they said, “We get in trouble with the executives/board of our company if we are off-budget, so a periodic re-budgeting practice is essential for that not to happen!”)
Some companies use budgets to indirectly erase their past recent performance. They negotiate down to numbers that they think they are safe in attaining. This is like a football team convincing the coach at the start of the season that their field should be 90 yards long on offense as opposed to last year’s 100 yards.
Many companies use the budget as the annual target in which to base bonuses on. Now, that is really illogical because it has nothing to do with the relative competitive posture of the comparable industry. What is critical in business is your relative performance against competitors. Therefore, you should be incentivizing people to improve beyond your competitors. Plus, using the budget as the bonus hurdle promotes initial conservatism of goal setting rather than creating stretched or aspirational goals. It also disregards longer term rolling company performance trends by erasing the past history. A company can unknowingly shrink to death slowly over the years by resetting the starting point to the first day of each new fiscal year.
Now are there very good uses for a budget? YES, and I am being slightly tongue-in-cheek. CFOs need them for banking and capital planning. But in my experience the budget negotiating process is not in line with the distraction, time and emotional energy the effort takes. Let Newton produce the budget and take all the time your team won back to find out what your clients want. Get external and compare yourself with the top quartile of your competitors. Management’s overall job is to improve in the comparative ‘league tables of profitability.’
© 2017 Robert Uhler and THE UHLER GROUP. All rights reserved.