Babies, bathwater, and best practices – Rethinking planning, budgeting, and forecasting

If everyone is thinking alike, then somebody isn’t thinking – George S. Patton

If planning, budgeting, and forecasting isn’t delivering the value your business expects, it may be time for a good scrubbing. But don’t throw it out.

How we got here

The basic tools of accounting—double-entry bookkeeping, income statement, and balance sheet—can be traced to Venetian investors who funded trade expeditions to Asia during the 1400s. These were valuable tools for high-risk ventures, even by today’s standards.

The concept of planning and budgeting came centuries later. The word “budget” derives from the old French bougette, meaning a small purse. In the mid-1700s, Great Britain’s Chancellor of the Exchequer was said “to open the budget” when presenting his annual statement. The term was extended to private and commercial finances in the late 1800s.

At the beginning of the 20th century, business leaders made a defining choice that sowed the seeds of today’s frustration. With outside investors demanding audited financial statements, managers began to rely on external financial reports as measures of internal performance. They believed it was too time consuming and expensive to produce two sets of manual reports.

The voice of reason?

Most organizations don’t have to dig very deep to find people who don’t like planning, budgeting, and forecasting. You might even be one of them. The stress associated with these activities can be enough to wear down anyone’s resolve. With business units protesting in one ear and executive management grumbling in the other, it’s no wonder finance leaders may be tempted to listen to some pundits’ advice and abandon these activities altogether.

But while the complaining may be frustrating, it can also provide clues to what may not be working. Time-consuming manual processes. Endless budget iterations. Wasted technology. Conflicting goals. Poor decision-making. These are the things you could easily do without.

But don’t get carried away. Companies count on finance leaders to be their voices of reason—cool in the heat of battle, skeptical in the face of exuberance, and above all, focused on creating value. In the final analysis, planning, budgeting, and forecasting is a powerful tool – perhaps the most powerful tool—for informing and executing your business strategy.

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Filed under: Executive Leadership, Finance, accounting, balance sheet, bookkeeping, budgeting, business, ceo, CFO, Deloitte, executive management, finance, financial reports, forecasting, income statement, leadership, management, planning

Cash is king

Just a catchphrase or a mantra by which to run a business? In our opinion, it is most definitely the latter.

In difficult and unpredictable economic periods, many businesses will inevitably look to review their strategic options. However, a key focus area will always need to include the implementation of stricter cash management and forecasting controls, with the aim of securing maximum cash return.

Even during economic growth and boom periods, a common observation for successful and highly profitable businesses is a very clear understanding of the relevant cash profile and strong financial reporting controls in this regard. Conversely, strong indicators of a struggling business include a lack of cash focus and a poor management grasp of potential funding requirements over both the short and longer term.

Whilst this may seem an obvious observation to make, the failure of companies with a seemingly strong product and business plan suggests that this is not fully appreciated by all senior management teams. We have seen examples of this with both start up operations and more mature businesses.

When starting a business, cash requirements will be considered, however, robust reporting mechanisms and procedures appear to be lacking. Management tends to focus on production, supply chain distribution and product marketing, with rigorous financial reporting controls only considered when the business is at a more established stage. Generally, the implementation of stringent financial reporting and cash management controls are viewed as a development and growth barrier, with such controls considered more appropriate once the business sufficiently matures. In addition, we have observed in a number of due diligence projects that a general trend of over-optimism for operational growth has resulted in forecast funding requirements being understated. Therefore, management realises that the operations are running out of cash literally days before the necessary funding is required (generally to pay salaries) and even in these situations, management has limited visibility of whether additional funding will be required beyond that point.

With an established, struggling business cash management reporting and forecasting controls tend to have lapsed during times when the company was profitable and cash generative. As a result, when trading conditions deteriorate, the management team is left with limited visibility of what is driving the downturn in fortunes or appropriate information to be able to understand how much additional funding will be required or how to generate a rigorous and achievable turnaround plan.

All too often we see examples of management that is unable to clearly answer seemingly simple questions such as the reasons for deterioration of profit margins on product sales, impact of foreign exchange on their business or likely timing of trade receivable collections.

With this in mind, we recommend that all businesses, even those performing strongly, consider the following key questions:

• Can you accurately understand the recent trends in profitability of your business and quickly provide analysis to support this?
• Do you produce a short term cash flow forecast and therefore understand the funding requirements for your business over the next three months?
• Do you have a clear understanding of the timing of cash receipts of your current trade receivables ledger and how this matches against upcoming payments to trade payables?
• Do the sales and purchase ledger teams understand the cash management goals of senior management?
• Does your financial team understand the production schedule and raw material purchases that the production team are expecting over the coming months?
• Is your longer term forecast updated on a regular basis for current trading trends? In addition is your forecast flexible enough to perform a sensitivity analysis of projected free cash flows?

If the answer to any of these questions is no, then we recommend that the business considers their cash controls, financial controls and forecasting. There may be a time when having these simple controls in place will be vital to the survival of their operations.

Article compiled by Clinton Wolder (Manager at Deloitte Corporate Finance) and Stuart Wilson (Associate Director at Deloitte Corporate Finance)

Filed under: Executive Leadership, Finance, business strategy, cash management, economics, financial controls, forecasting, management