In a typical manufacturing company, it is common to see full automation in the areas of inventory control, production control (e.g., shop floor control, scheduling, capacity planning) and of course the common functions of sales orders, purchasing (with or without MRP), accounts receivable, accounts payable and general ledger.
In addition, more and more manufacturers have implemented automated employee time collection at work centers or even at specific machines or production activities. Cost accounting has become more automated and shop rates are periodically analyzed and corrected as required to arrive at a more precise product costing, more accurate cost absorption in inventory, and more accurate and appropriate inventory valuation.
While all of this is encouraging, there is one very important area in manufacturing finance that many companies still struggle with: the much-dreaded process of budgeting, forecasting and analysis.
Some manufacturing companies still use spreadsheets for their annual budgets. They may consolidate several or many spreadsheets prepared by their various administrative and operations departments, and some of them may have some logic built-in to aid the forecasting process. Invariably, the end result is only a projected income statement (P&L) with one column for each budget period (e.g., month). There is usually no further insight into the future financial health of the organization.
Another common behavior is the lack of ability or discipline to regularly analyze these forecasts against actual accounting data. The result of this behavior is the inability to make informed decisions and align the company operations with its goals. In many situations this leads to financial deterioration and having to make drastic corrections, often as a result of overreacting to symptoms.
Fortunately, this can be prevented, and relatively easily, by employing a robust approach to budgeting and by using the right software tools.
Today there are many budgeting, forecasting and business intelligence solutions available to manufacturing companies. But in order to be successful, no matter what solution is implemented, it must be practical to set up and use and most importantly, it must encourage users to embrace the process and welcome it; in other words, encourage people to use it because they “want to” and not because they “have to.” In many cases, this will make the difference between a successful and failed implementation.
Other than the approach and attitude towards the solution there are, of course, certain technical requirements the system must meet in order to provide the expected benefits to these organizations.
The following Top 10 list highlights the more important features and benefits of a budgeting, forecasting and business intelligence application to successfully meet the needs of a manufacturing company today.
1. Must be delivered as a database application for better control and management, as commonly used spreadsheets are not the right environment for this process, are prone to errors and cannot be managed and updated easily and regularly. Many of the essential forecasted financial statements and other reports cannot realistically be programmed in a spreadsheet.
2. Should have a system-generated integrated set of forecasted financial statements. These must include an income dtatement, a balance sheet and a statement of cash flows. Other user-defined reports should be available. All financial statements and reports should be system-generated with no user programming or placement of formulas and links within the program. This is critical, as user programming is time-consuming and generally results in errors and omissions, some of which are never discovered but always impact accuracy and completeness of financial statements.
3. Must have a modular approach with a complete array of functions such as: revenue forecasting module with cost; operating expense module; personnel module; fixed assets module; loans and other debt module, etc. Of particular importance to manufacturing organizations should be the ability to accurately forecast their personnel expenses. The personnel module within the budgeting solution must be comprehensive and allow for unlimited types of employees, either budgeted individually or in groups of similar functions, with overtime, shift differential and other specific details required by each company. It must have automatically calculated payroll-related expenses and use drivers when required by users (see below).
4. Driver-based forecasting, which is the ability to work with unlimited and varied types of drivers. Examples might be: utilization rate, unit price, square footage, outgoing sales calls, machine-hour capacity, etc. Budgeted revenue and expense items are automatically calculated by (driven by) these user-defined drivers and follow the behavior of these drivers. In a manufacturing environment, direct labor expense can be dependent on certain drivers, which can also drive certain revenue items and their associated COGS. It is important to note that these drivers must automatically drive the calculations and never rely on user programming and placement of formulas, functions and links in the software.
5. Ability to allocate forecasted amounts to pre-defined accounts. This is particularly important to manufacturing companies that use full absorption costing where all production-related expenses (direct and indirect, including manufacturing overhead) must be allocated and absorbed into inventory produced in each accounting period. This will ensure US GAAP compliance and produce forecasted financial statements in line with the already familiar financial statements, which are based on actual accounting data. The allocation in the budgeting process should mimic the method used in the actual cost accounting. When a personnel module is used within the selected budgeting solution, specific payroll and payroll-related expenses should also be accurately allocated to be absorbed into inventory.
6. Business intelligence and rules must be built-in and available to users to choose from. Experience shows that programming rules and other formulas and links can be very time-consuming, will most certainly result in material errors and omissions, and will make the maintenance of the budget model nearly impossible and extremely costly. It is important to note that migrating the budget process from a spreadsheet-based solution to a dedicated software application can often reveal the same fundamental flows that spreadsheets have (albeit the added security in a database application). Users of such applications often have to apply a great deal of programming and model setup, and unless thorough reviews and change management are strictly enforced, the risk of errors and omissions always exists. When searching for a dedicated budgeting, forecasting and business intelligence solution it is imperative that users make sure the application they are evaluating does not require any programming or placement of formulas, functions, or links anywhere in the model.
7. The application chosen must allow users to set up a chart of accounts representing the actual accounting system’s chart of accounts (or mirroring it). This will allow a much simpler analysis of actual results against the budgeted data for any given period.
8. There should be either a direct link or simple interface to the accounting or ERP software’s general ledger, where actual data can easily be populated in the budgeting software and immediately used in the analysis process, following the accounting period close. The value of this cannot be overemphasized, as knowing how the organization performed compared with their goals and budget is the best (and probably the only) way to drive the decision-making process. The sooner this data is available, the better.
9. Reports—both visual and alpha numeric—must be readily available and with minimal effort. The ability to slice and dice through the existing and accumulating data can present users with different views of their data. The data must be displayed in a manner that can be clearly seen, then quickly understood, then immediately acted on to realign the organization with its original goals and budget. This can also be used to update the budget, or a combination of both.
10. The most important aspect of a well executed budgeting, forecasting and business intelligence software application is its ability to act as an extension of the accounting software or ERP system’s actual financial data. The idea is to be able to turn the budget and forecasting data (as obtained from various process participants) into a complete and accurate projection of future periods’ financial statements.
When the selected system is able to deliver on all 10 points listed above, the organization will be afforded a much better insight into the future financial health of the company and without adding unnecessary burden to its finance and operations functions.
Experience gained by many organizations, manufacturers included, shows that a proper budgeting, forecasting and business intelligence solution that is practical to implement and use throughout the budget year can become a trusted tool and will provide the insight and intelligence needed to drive the decision making process, quicker and with greater confidence.
Alan Hart is a former CFO with nearly 20 years of experience in accounting, finance and management. He works with Centage Corp. to evangelize driver-based budgeting and forecasting solutions.