June 20, 2017

Realistic Budgets

More than just satisfying the board and the bank

With the new financial year almost upon us, most businesses are turning their thoughts to finalising next year’s budget and being prepared for that all important presentation to the board or meeting with the bank. Regardless of size, it is important for any business to understand how much money it makes and how much money it spends in any given period. Budgets are effectively ‘business plans in numbers’, and without the ‘business plan’ part, the ‘numbers’ part can become a theoretical exercise designed to keep the chairman smiling and the bank convinced that there will be no covenant breaches ahead. Most importantly, the budget sets an expectation of future performance against which the business, and its management, will be continuously measured. 

Under-achievement can have numerous consequences beyond the board and the bank, though these could be serious enough. So are you looking at a budget that has been built for the right reasons and is realistically achievable? The first question that should be asked is: What is this budget hoping to achieve? The budget should reflect the strategic and operational goals that the business has set itself for the period. For example, increasing sales by 5% by expanding into a new territory; releasing a new product or service; or increasing administration efficiency through the implementation of new software tools, processes or procedures. Whatever the reason, these goals should be listed and the assumptions behind how they are going to be achieved clearly documented so that they can be easily articulated and defended. 

Businesses need to take a deep dive into the operational capability to deliver the budget, for each of the potential goals listed above, does the budget fully consider all the additional marketing and staff/resource expenses that are going to be involved? You have to ensure that the business is not creating a numbers scenario that cannot be practically implemented. Can existing sales staff really manage the 10 extra customer calls each week that will be required? When will they travel to the new territory that the budget has identified for growth? How often will they and for how long, what will this cost? How long before new sales can realistically be achieved? 

The second issue to consider are the performance KPIs and incentives that are likely to be linked to the budget. Leaving aside the debate around incentivising behaviours driven by short term KPIs that may actually be detrimental overall (such as rewarding sales reps for new customer numbers, without considering the effects of the discounted pricing at which these new customers were gained), staff are easily demotivated by continuously unachievable targets. Does the business really have the operational capability to deliver the rewards the performance budget promises, and if not, what is being done to change that?

Your business budget should also serve as an essential tool in business decision making. Without a realistic and validated budget, how can you recommend when the right time to invest in that new processing machinery or take on that extra sales person? Basing these types of decisions on untested assumptions regarding the validity of real operational performance forecasts can significantly increase business risk. Not surprisingly, business insolvency surveys show that running out of cash is one of the major reasons businesses fail (refer to the SV Partners Commercial Risk Outlook Report  March 2017). Your budget should allow decisions to be made that minimise the risk of this happening, if you are not convinced that this is the case, don’t let your budget reach the boardroom or the bank.

If you know a business that would benefit from the experience of our Strategic Solutions team in developing or just reviewing their budgets and cash flows to ensure they link to operational capability, please contact one of the team on 1800 246 801. 

Article written by Sheree Cross, Director, SV Strategic Solutions, Queensland

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