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 firstname.lastname@example.org.