|Budgeting serves as your company's benchmark
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Key drivers make the difference
Not every piece of your budget is a key driver of your business. Take a careful look at what expenses and operations drive your business. Is it operations, sales, marketing, finance, production? Those will be the key factors in your budget.
"You must budget for controls that will yield the most benefit," says McMurrian. For example, an accounting practice budgets for staff costs, billable hours and billable rates.
"If your write downs (the difference between your standard billable time and what your actually invoice) average 7 percent over the past five years, you can't set it at 4 percent in your budget and expect to achieve the desired result. But if your office supplies are at 18 percent, you can likely reduce those to 14 percent by implementing different controls," he says.
The budgeting process can be troublesome for smaller companies since many don't want to share financial information with employees. "Smaller companies' owners don't want their employees to know what they make. I suggest that they share those numbers and explain that budgeted earnings are not available for distribution—a portion may be owed to the bank or an owner because of the substantial amount of personal resources they put into starting the company," he says.
The most important thing is to go through the budgeting process because it is critical to the success of your company. "It's a documented fact that people who set goals in writing perform higher than those who don't. Budgeting and forecasting means setting expectations and, if needed, taking corrective action to meet those expectations," says Corum.
In a growing organization, it's necessary to tie growth to expectations on receivables because that will affect your cash flow. "If you're growing, you may need to budget for more equipment or more space," he says. "If business is shrinking, how do you cut expenses? Maybe you borrow cash for the lulls. If sales are down, receivables may be up, reflecting a down economic condition."
McMurrian agrees. "A business without a budget has no idea where it's going. They're not looking at market share or process improvements," he says.
Whatever measures you use must be global. "If I set a goal for a sales person to meet, but his margins are inappropriate, I've defeated the purpose of setting goals," he says. Those sales goals need to be coordinated with purchasing, marketing and finance.
If you set goals based on budgets that are used as benchmarks, then they must not be used as whipping tools, says Corum. "There's a saying by Dr. Eliyahu Goldratt, 'Tell me how you'll measure me and I will tell you how I will behave. If you measure me in an illogical wayÉ then do not complain about illogical behavior.' If you use that approach, you'll be in conflict with other measures in the company."
For example, in a manufacturing organization, if a lathe operator gets measured based on the amount of product he produces, there can be problems. "Say a manufacturer runs two shifts. The second shift can't make product because they couldn't find the die. The first shift manager took the die home so that he could control the amount of product made during his shift, financially benefiting him."
Budgets remain largely tied to compensation incentives. McMurrian says that in companies with more skilled workers, establishing an incentive pool to be distributed to all employees if they "beat budget numbers" is a worthwhile incentive. "However, that approach doesn't work in a company with many non-skilled employees since those people need the money on a week-to-week basis, not at year's end," says McMurrian.
"You can offer incentives to the plant manager based on his budget, although that doesn't immediately filter to his staff. It will, however, filter to them the next year when raises are higher as a result of beating the budget numbers."
There's also a risk that those formulating budgets will tend to lowball their numbers. "There is a tendency to be as conservative as possible," explains McMurrian. "You don't want to stick your neck out—you want the budget to be as financially beneficial to you as possible.
"We understand people's nature to be conservative," says McMurrian. "But if you build in the mentality at the business planning stage, your willingness to stick your neck out and push will go a long way toward building the incentive pool, then you've positioned yourself to be on the leading edge of growth."
The budget is your tool for getting there. "It's your on-board satellite system," he says.
Corum says that the common behavior among his successful clients is that they all budget. "They are realistic optimists. Most expenses are fixed and they can see what happens to their cash flow and make adjustments when needed," he says.
"These business owners know on a daily basis how much money they make. Financial statements are just confirmation of that budget. In many ways it's easier for smaller businesses to manage this part of the financial process," adds Corum.
"I think that too many business owners get hung up on the little details. They end up worrying about the phone bill when really that is a fixed cost. You can't get too myopic. Look at labor, materials, sales and remember that 20 percent of your items make up 80 percent of your budget."
To those who dread the process, Corum recommends you "just do it. Go through the pain because the more you do it, the more refined the process will get." e