A new year, like a new job or a new baby,
comes full of promise. The hassles of
last year are gone, and the first months of a year are filled with hopes of better business, better profits and better performance.
And those hopes can be fulfilled — if we get
things lined up today, so we can improve the
bottom line in 2008. Since it all comes down
to dollars and sense, we asked Bob Friend,
senior vice president at FirstMerit Bank, to
gift-wrap some good ideas on how to benchmark performance improvement.
How important is budgeting in the annual
review process?
Establishing a budget that encompasses
the direction that the company wants to go is
an essential part of the planning process for
the coming year. The budget process, if done
properly, enables the company to review
sales plans and expectations, review cost
structures and plan for impact on cash flow.
In addition, the process provides the company an opportunity to consider different
options and their impacts. Such items to be
considered would be the impact of significant growth in sales and the effect on the cost
structure. Questions need to be asked, such
as: Can the increase truly be achieved? If so,
will the cost structure be able to be maintained? What is the impact on cash flow if
higher levels of inventory are needed to
achieve the sales level? The budget process
lets management review various scenarios to
determine the most desirable result, the likelihood of achieving the result and the overall
impact on the company.
What are the key measurements to be
reviewed in the budget process?
The principal items to be considered in
preparing the budget are sales levels,
changes to the existing cost structure and significant cash flow events, such as capital
expenditures, debt repayment or distributions. Resolving these major items allows the
income statement to be generated and operating performance to be determined. Other
factors include expected changes in receivable and inventory turns. A significant
change in either could have a major impact
on the expected cash flows of the business.
Who should be involved in the process?
Although the budgeting process is typically
a management-directed exercise, it is important to get everyone’s input. The key is to get
the concurrence of the expectations and
assumptions in the process, especially from
those that can impact the results. Without the
input of the parties that direct activities, key
assumptions can be incorrect, leading to
faulty conclusions. For example, if purchasing is not involved in establishing the margin
assumptions, recent price increases may not
be factored in. Also, it is important that everyone on the team is aware of the targets and
goals for the coming year and agrees that the
budgeted results are achievable. In this way,
everyone has a vested interest in the success
of the plan and can take ownership in the
plan. Getting all of the key people involved in
the process keeps the company headed in a
unified direction.
Whom should a business use as advisers in
reviewing plans for the coming year?
Each company’s owners will have different
key advisers, whether they are suppliers,
industry experts or professionals, but I think
there are four key advisers that a company
should use during the annual planning
process. They are the company’s accountant,
lawyer, insurance agent and banker. Each of those advisers looks at the financial statements from a different perspective. The
accountant can look for ways to implement
various tax strategies. The insurance agent
will make sure the level of coverage is adequate, especially if significant growth is
planned or a new line of business is anticipated. Similarly, the attorney needs to be
aware of any organization changes that may
be anticipated or liability issues that may
result. Finally, the banker needs to be aware
if events will affect the current loans or if new
borrowings are anticipated so that a proper
structure can be put in place. The company
does not want to start down a path that’s not
achievable due to an improper assumption.
Meeting with advisers can help test the
assumptions and conclusions reached. This
process will greatly assist in eliminating
potentially unwanted surprises.
How should advisers be used in the process?
It’s important that advisers are used
throughout the process, as assumptions and
planning are completed. The advisers should
help test the goals and assumptions. If the
advisers are not consulted during key phases
of the process, the company can get to the
end of the budget process with completely
erroneous results. For example, the company may need to make a significant capital
expenditure to reach certain sales levels and
assumes the equipment can be easily
financed. A discussion with the banker will
provide guidance into how much financing is
likely to be acceptable, along with potential
terms, such as repayment. Without that, the
company could start generating the sales
without the ability to obtain the necessary
equipment. The planning and budgeting
process is a key step to set the goals, directions and expectations for the year. It’s key
that management gets involvement and buyin from everyone involved in the execution of
the plan. Finally, it’s essential that key advisers test the assumptions and conclusions
reached to end the process with a plan that is
not only accurate, but also achievable.
BOB FRIEND is senior vice president of commercial banking,
FirstMerit Bank in Columbus. Reach him at (614) 545-2763 or
[email protected].