Talk of recession in the United States has been in the air. Whether this actually happens within the next six months or so remains to be seen, but the speculation itself should be a wake-up call for CFOs and controllers to take a close look at their planning processes.
For most businesses, there aren't a lot of silver linings in economic downturns, except this one: If you are prepared, your company stands a better chance of gaining ground on the competition during a downturn than when times are good. Preparing for the bad times is a strategic imperative, especially for the finance organization -- and preparation takes planning, not just budgeting.
Remember that planning and budgeting are separate processes. A plan lays out a company's course of action; the budget translates this plan into the financial resources the business expects to generate and will need to operate. Planning is about things; budgeting is about money.
Planning well means orchestrating how all of the parts of the business connect to the company's strategy and capabilities through a coordinated set of actions. Successful planning helps to achieve business objectives; budgeting well means keeping expenses in check and ensuring that cash is available. Planning is about succeeding; budgeting is about not failing.
Obviously, both are important, but we find that changing the traditional budgeting process to one that is planning-oriented is an important step in enhancing the effectiveness of the finance organization and improving corporate performance. This is even more true in a downturn, when anticipating how best to react to change can enable a company to do a better job of cutting outlays and resources to less important parts of the business while favoring the most strategic.
Surveys of finance executives during the last downturn at the start of this decade found that most of them relied on capital spending to ensure that there was sufficient cash to run the business. Since the capital budget is usually a big percentage of how companies use funds, this is not surprising. However, one survey also showed that CFOs who had been in their current job five years or longer relied less on capital expenditures to modulate their cash flows. The survey did not explore why this was so, but we suspect that it was because those finance executives were in a better position to understand where they could cut unnecessary spending. After considerable experience, they understood exactly where they could make cuts.
Planning is not a perfect substitute for experience. Yet, just as airline pilots are better able to manage a midair crisis because they have spent hours in simulators, CFOs and controllers who do in-depth "what if" planning to explore how best to respond to unfavorable turns in business will be in a better, more confident position to make the right moves.
We find that companies rarely bring together their planning and budgeting into a cohesive process. Sales and revenue forecasts and operating plans play some role in the budgeting process, but few corporations have comprehensive, driver-based plans in place. Such plans would enable the business to assess the impact of falling demand on both the revenue and expense sides, as well as on plant utilization, numbers of employee hours needed in stores, administrative head count requirements, and so on.
Rather than doing simple ratio analyses, driver-based plans can explicitly factor in commodity prices and other direct costs. Doing this allows executives to determine, for example, if business unit A is more strategic than business unit B, what the impact would be of starting to cut costs in B ahead of a downturn in demand in order to try to gain market share in A. Knowing the precise impact of such actions can enable management to make more precise judgments than, say, calling for a 5 percent cut across the board.
What prevents companies from doing this kind of comprehensive, driver-based business modeling? For many, it's software; for others, it's just habit. Our research shows that about half of all companies with 1,000 or more employees still use spreadsheets to manage their budgeting process. Especially for these larger companies, it is impractical to try to create and manage a driver-based planning process using desktop spreadsheets. With so many choices of planning software available at a range of prices, companies that continue to use spreadsheets should evaluate what they are missing by letting this habit persist.
Many companies purchased planning and budgeting software during the past several years, yet we find that a majority of them have not taken full advantage of the tools' capabilities. For example, few have used them to do precise "what if" analyses to improve their understanding of how best to react to changes in the business climate. This is not an especially difficult task that requires expensive consulting time -- it mainly requires a commitment to changing the focus from creating an annual budget (which quickly becomes irrelevant to managing the business) to building a planning process that can help to coordinate business execution.
The time to change is not in the throes of a downturn, when the focus turns to pressing day-to-day issues. The time to change is now, when the prospect of a recession and its impact ought to motivate CFOs and controllers to develop methods to improve how they plan and react to market and economic challenges.
Links:
[1] http://www.businessfinancemag.com/magazine/archives/issues/2008/February/39.gif