Posts Taged deliberate

The One Year, Thirty Minute Challenge :: Week 43 :: Finance :: Operating Budget

According to a survey by Clutch, 61% of small business owners did not create an annual operating budget. As the number of employees shrunk, the likelihood of a business creating an annual budget shrunk even more – 74% of businesses with 1-10 employees did not create a budget. Unsurprisingly, in another Clutch survey, 35% of small business owners listed unforeseen expenses as their top financial challenge.

An operating budget certainly doesn’t insulate you from unforeseen expenses, but it does force you to deliberately examine projected revenue and expense numbers for the upcoming financial period. The exercise, if done correctly, will make you prove, with real math, that your strategic and operational plans are going to deliver the financial results you desire.

Earlier in the One Year, Thirty Minute Challenge we looked at capital budgeting. Operating budgets differ radically from capital budgets. Capital budgets deal with large-ticket items that are depreciated over several years. Their purchase is not reflected in an operating budget. Operating budgets deal with income and expense projections for an upcoming fiscal period. Money that is typically both earned and spent in that period.

Operating budgets are based on assumptions – assumptions like “what we pay for utilities will stay the same”, “we will have no major customer defections”, “our health care premiums will go up 10%” and on and on. At the beginning of the budgeting period, you’ve got to validate every assumption as much as possible. It’s also prudent to document assumptions so everyone involved knows the “facts” the budget was built on. To illustrate, in 2020, you should assess and state your assumption about the effect of the coronavirus pandemic on your organization in 2021 – it will be a distant memory, we’ll be somewhat impacted, it will still be a major factor for us or somewhere across that spectrum.

Clearly, your 30-minute exercise this week isn’t long enough to pull together a budget, so the goal is to pull together a budget plan, get the plan to the right people and be able to clearly explain your budget methodology.

According to the Corporate Finance Institute, there are four methods for putting together an operating budget –

  • Incremental – Start with last year’s actual revenue and expense numbers and ratchet them up or down based on a percentage or on anticipated changes in specific budget categories. I’m not a fan of this methodology, since it’s easy to perpetuate a budget that might have been built incorrectly in the beginning. And, it might be feeding budget categories that are no longer relevant to the success of the business.
  • Activity-based – Begins with revenue targets then fleshes out the expenses needed to reach those revenue targets. This methodology works well for “cost of goods sold” expenses but might be a bit unruly when building the underlying administrative costs.
  • Value proposition – Requires every expense to be tied back to some value creation activity for the customer, employee, shareholder, or other stakeholder. I like the premise here because, truly, if an activity doesn’t bring value, then why do it?
  • Zero-based – Every single budget line begins at zero. From scratch, you must build every line item. Consequently, the existence of the line item and the amount must be justified. I like this one also, because of the discipline required and the scrutiny given to each entry.

 

You can choose one of these methodologies or a hybrid of two or three. The methodology takes a backseat to the real reason for doing a budget – to correctly fund value creation activities so that projected revenue goals are met or exceeded and expenses are right-sized so that all stakeholders receive returns that cement their relationship to the company. This incredibly important point deserves a bit more attention. Customer facing activities must be sufficiently funded so that purchasers receive a product or service that exceeds their expectations and is delivered in a way that makes them feel good about their purchase. Employee compensation must keep value producers inside the organization happy and engaged and not looking for employment elsewhere. Shareholders must receive a sufficient return so their investment in the organization continues to be justified. A similar calculation must be made for every stakeholder in the organization.

Let’s jump into a few mechanics for budget building.

  • Involve the people ultimately accountable for hitting the numbers – The directors and managers who will reap the rewards or bear the consequences for financial performance for the budget entity (department, division, business unit) must create the budget for that entity. If they’re smart, they’ll involve other team members who will impact that entity’s performance.
  • Simultaneously work bottom up and top down – Expectations for profitability should be communicated down and needs for funding value creation activities should be communicated up. The organization’s desired endgame should be baked into the company culture and should be a regularly discussed topic in the organization, so there shouldn’t be any surprises here. This is just an annual exercise dedicated to examining the financial manifestations of what you’re after every day.
  • Use tools that make sense – A smaller organization might get away with an Excel template used by everyone in the organization. Larger organizations probably want to opt for some of the more robust budgeting tools available.
  • Use the right level of detail – In your office supply category, you don’t need a line item for pencils, another for staples and another for paper clips. If you do, you have the wrong people in charge. Budgets reflect the level of autonomy in that business entity.
  • Budgets should include contingencies, but those building the budgets should know that the ultimate determinant of investment is value creation – I’m in favor of adding some contingencies to a budget (for unforeseen circumstances – overtime, equipment failure, opportunity to capture an emergent opportunity), but ultimately, every expenditure in an organization should be about value creation. If a situation arises that affords an opportunity for value creation, even though that opportunity was not apparent at budget creation time, the person responsible for that budget entity should know that they can come to you with that opportunity and not be chastised for considering something “not in the budget.”
  • Budgets function as a “reality check” for projected revenue and projected expense – Let’s say your budgeted revenue reflects the sale of 3 million widgets. What is the sales commission for 3 million widgets? What is the cost of raw materials for 3 million widgets? What is the labor cost for 3 million widgets (that requires that you know how long it takes to make each individual widget)? Will any overtime be required to produce 3 million widgets? Is the present capacity of your plant sufficient to produce 3 million widgets? What does it cost to ship 3 million widgets? Will the production of 3 million widgets force you to add another shift? What will be the cost of supervisors for that shift? Are all those items in your budget? The budgeting process is the mechanism that ensures you’ve accurately identified and synced all of the revenue and costs associated with the value creation activities that get you to your financial targets.
  • At some point in the process, check your work against industry benchmarks – I’m not a big “best practices” person. Every “best practice” was once a wild idea gambled on by some innovative thinker. I’d prefer to put my money on the innovative thinker. However, that being said, it’s not a bad idea to check your work against your competitors – just to make sure you’re not missing something. For instance, you can easily find stats on what percent of revenue is spent on Information Technology in your industry. If your competitors are spending 4% of revenue on IT and you’re spending 2%, maybe you’re not being thrifty. Maybe you’re missing opportunities to automate work or offer new tech-enabled products.
  • Bake in profit margins at the budget level – If you want to make a profit of 20%, make sure your revenue and expense projections enforce that margin. Engineer the value creation activities until you’ve pushed the revenue and expense numbers far enough apart to hit your profit target.

 

Get the responsible parties together and lay out your plan. If this is your first budget, it’s important to explain your rationale. It’s all about the discipline – the same reason you do a strategic plan or any other deliberate planning activity. It’s the opportunity to step away from the press of all the things that clamor for your attention and focus on, in this case, the finances of your organization.

After your budget is in place, check your performance against it regularly. Make it a part of your balanced scorecard. When opportunities come to deviate from it, use it as a development opportunity for your staff as you discuss the rationale behind decisions to “stick to it” or “stray from it”.

The One Year, Thirty Minute Challenge :: Week 39 :: Strategic Planning :: Annual Plan

Strategic Plans fail at an alarming rate. According to The Balanced Scorecard, 90% of businesses fail to execute their strategies successfully. According to onstrategyhq.com, 95% of employees don’t understand their organization’s strategic plan and 60% of companies don’t link strategy to budget. If those are the stats, why even engage in the Strategic Planning process at all?

First, there’s value in the process. General, and later President, Dwight Eisenhower said, “In preparing for battle, I have always found that plans are useless, but planning is indispensable.” Every plan, whether it’s for a military campaign or for running a donut shop, is built on informed theory and assumptions. But the minute those plans are implemented, they become vulnerable to forces outside our control. The enemy has more artillery than we anticipated. The muffin shop down the street lowers their prices. Does that mean it’s time to abandon our plan? That all our planning effort was wasted? No, it means just the opposite. If we exercised the discipline to plan thoroughly, we contemplated multiple actions and the anticipated outcomes for each. We chose one, or possibly a couple, of those actions and assembled the resources to execute it. But the real value in planning was that we analyzed all of the possible actions, all of the possible outcomes and all of the resources necessary to execute those actions. Now this knowledge is at our disposal. So, when reality collides with our plan and our initial choices don’t seem so wise, we already have a wealth of accumulated thought on how to readjust and redeploy our resources to still achieve our original objective.

Second, there’s value in the discipline. It is very easy to be caught in the tyranny of the urgent. Crises with employees, customers, vendors, equipment, and money can consume every waking work minute. Dedicating time for deliberate planning gets us off the hamster wheel of constant busyness. The discipline of –

  • thoughtfully examining our human resources – the people we have now and the people we’ll need in the future
  • carefully evaluating our value creation activities – supply chain, transformation activities, vendor performance
  • revisiting our financial management – liquidity, cash management, return on invested capital
  • carefully considering our market – customer problems we are solving, messaging, competitors
  • taking the temperature of our organization – culture, metrics

helps us see things clearly and truthfully with fresh eyes and more accurately plot a new course that moves us closer to our vision for the organization.

Finally, the biggest reason that Strategic Plans fail is lack of execution. Execution must be baked into the plan from the beginning and pursued fanatically through the entire organization as the plan is rolled out. A good Strategic Planning methodology leans heavily to the implementation side.

Let’s jump into this week’s One Year, Thirty Minute Challenge. Clearly you won’t finish your thirty-minute exercise with a strategic plan, but that’s not the goal. The goal for this week’s challenge is to identify the people who will be involved, set up a time and decide on a process.

  • Good strategic plans require input from up and down the food chain. The larger the organization, the more difficult this becomes. As organizations grow, people at the top necessarily move away from important value creation activities and customer interactions. But it’s just those activities and interactions that must inform future strategic plans. The first order of business is making sure that all the information you need to get an accurate picture of the current state of your organization is in the room. Gathering that information and involving people in the strategic planning process who can accurately interpret and advocate for the stakeholder interests represented by that information is crucial.
  • Put in on the calendar and don’t let anything displace it. Find a time and make it happen. Depending on the size of your organization and how solidly your mission, vision and core values are defined, it might take a day, or it might take a week. If you’ve spent time to carefully define your mission and vision and are solid on your core values, you can jump straight into your strategic planning exercise. If those things are new to you, you’ll want to spend time on those first. For a frame of reference, when I’m doing this with a client ($2 – $20 million in revenue), we go at least 3 full days or 6 half days or a bit more depending on what we find as we define the current state of the organization. Once you’ve put it on the calendar make sure you protect the time both for yourself and for those working with you on the plan.
  • Decide on a process. There are a number of good strategic planning processes and tools out there. They range from the one-page variety to more complete and detailed frameworks. Remember, much of the value is in the discipline of the exercise, so no matter the framework, utilize fully, think deeply and create deliberately. Here are the things you want to look for in whatever framework you use.
    • Get an accurate picture of the current state of your organization. One of the most prevalent and most damaging mistakes in a strategic planning exercise is failing to get an accurate picture of where you are now as an organization. You spend a lot of time on where you want to go but not nearly enough on where you are now. How can you make a map from here to there unless know your current location? Find a tool with powerful assessment tools.
    • Create several fully-loaded future scenarios. With your knowledge of the current state of your organization, your assessment of your place in the external environment (with customers, competitors, regulators) and the efficacy of your products or services to successfully solve problems for current and potential customers, craft a number of strategic alternatives. These alternatives might solve a personnel problem, correct an operational deficiency, exploit a market opportunity, recreate an existing product or service or tech-enable your customer experience. Some alternatives might play well with others. Some might be bold and very different from what you’re doing now.
    • Evaluate and choose the best opportunities. Your framework should give you tools to evaluate your alternatives in the light of financial return on investment (measuring the impact on shareholders in the long-term and in the short-term). You should also evaluate your alternatives considering employee experience, customer experience, regulatory compliance and, of course, in how much the alternative will push your organization closer to your vision. This part of the exercise should yield three, or at the most four, initiatives that you’ll be implementing over the next 12-18 months.
    • Execute like crazy. Employ an implementation framework that lets you rollout the why and the what for the selected initiatives to every person in the organization. This framework must enable every team member to connect the dots between their job and the new initiatives. It must include accountability mechanisms and a scoring framework so that everyone knows how the organization is progressing toward its strategic initiatives.

If you want to safeguard the long-term health and viability of your organization, you need to do a regular Strategic Planning exercise. The discipline of critically evaluating your organization and making measured course corrections is the best insurance I know to keep you out of the trash heap of irrelevant, failed enterprises.

If you want more information on the strategic planning framework I use, contact me at mchirveno@clearvision.consulting.

I Want to do for Strategy what Chip and Joanna Gaines did for Shiplap

I’m going to go out on a limb here and guess that six years ago, you had no idea what shiplap was. Neither did I. But thanks to Chip and Joanna Gaines and their hit HGTV show FixerUpper, shiplap is now part of the national consciousness. Everyone wants at least an accent wall’s worth of six-inch, horizontal wood goodness in their home.

Even though shiplap has been around for decades, it took someone to champion it – to sing its praises to a new generation of homeowners. I want to do for strategy what Chip and Joanna Gaines did for shiplap.

I love strategy –

Truthful evaluation, thoughtful options and deliberate actions to move an organization from the current state to the desired state.

Leaders in every organization feel the tension of the gap between where they are and where they want to be. That tension is supposed to be there. It’s one of the things that gets us to the office, shop, kitchen or factory every morning. But tragically, many leaders feel the pressure to close the gap but lack the tools to make it happen. Leaders randomly marshal the resources of traditional functional areas like marketing, production, finance and HR to transform the organization and close the gap, but in the absence of an overarching discipline that coordinates the objectives and work of these functional areas, the transformation is uneven and short-lived and the organization reverts back to business as usual. Businesses of 6, 8 or 10 people need the same overarching discipline, just like businesses of 6, 8 or 10 thousand.

That’s why I love strategy. It’s the neglected discipline – the one that, when employed, spurs conversation, creates collaboration and generates a singular focus for the organization. It’s the discipline that deliberately and methodically moves the organization to where it wants to be and, in the process, engages and builds up everyone involved.

Just like every homeowner who says, “I’ve got to have some shiplap in my house”, if I can get a business owner or manager, no matter the size of their enterprise, to say, “I have to incorporate strategic planning into my organization”, I’ve done my job. And if I have the privilege of helping them in that process, that’s a bonus.