Allsop says focusing on the budget is a perfect time to review fixed and variable costs.
“That’s a time to look at whether the fixed and variable cost structure is still appropriate where costs can be reviewed and contained or removed. Or, perhaps, they might need to be added to enhance business operations,’’ Allsop says.
“But rather than look at last year’s costs and add CPI to them, inform your next year’s costs. It’s always good to take time to consider them and perhaps go back to suppliers and negotiate.
“But, if you are going to negotiate, that would extend the time length of the process. If you are looking to do that, I would start the process a little earlier. I would allow an additional three or four weeks.”
Allsop says budget time is also when the business should be looking at economies of scale with departments like HR and IT. It’s also a good idea to look at areas of duplication.
Most budget specialists say ‘top-down/bottom-up’ is the way to prepare the budget.
Downes says the ‘top-down’ process starts with the CEO spelling out what the business objectives are over the next 12 months. “He needs to put a stake in the ground,” Downes says.
“Top-down process is where business owners say we want to see a 5-10% increase in the size of the business over the coming 12 months or we want to minimise the risks of business degradation to flat-line growth.
“That puts a stake in the ground that needs to be presented to their management team: It might be divisional leaders or product segment leaders or geographic office leaders. They then need to pass that down their process to their management team to pull together a budget to deliver top line expected results.
“The bottom-up scenario is what the management team pulls together. They need to look at the revenue coming into the business on a by-client or by-product or by-service or by-geography basis or local perspective and then actually make a budget forecast about what that revenue could, should or can be.
“The more granular they make that, the more effective the process is because they are thinking of specific clients and how those clients or products or services will perform.
“It is very much about dealing with what is possible.”
Dwyer says the top-down process brings a strategic focus on the budget. “You have to get a base line across all sort of expenditure, across elements like maintenance, labour and advertising. And, with that base line, you have a strategy,” he says.
“Do you intend to expand into niche areas? What additional costs are we going to have to expand into that niche?
“You then look at your existing market. Are you going to have an increase in market share? What are the revenue impacts and what are the cost impacts?”
The bottom-up process, he says, comes from the people in operations who work out what the costs are and what they are likely to be.
The trick, he says, is seeing what you get when you combine the two.
“You take a look at the top-down and bottom-up and see where you have the gaps,’’ he says.
Intelligence gathering is critical. Businesses need to know what competitors, customers and suppliers are doing in determining where they should be focusing their budget efforts.
Dwyer says businesses need to gather intelligence three months before the major budget-planning process.
“You could be looking to see what your competitors are doing, looking to see how the distributors are doing and looking at all your channels going back three to four years,” he says.
“And, for the last 10 years, the internet has been playing havoc with channels and the NBN is going to play havoc again.
“It’s a PESTLE analysis. You get the Political, the Economic, the Social, the Technical, the Legal and the Environmental. That’s a good analysis and you do it three months out to see what the external environment is doing.
Barolsky says companies should be doing some benchmark analysis as part of that intelligence gathering process. “They will get it from their accountant or they can buy comparative data,’’ Barolsky says.
“Let’s say, for example, you have a car dealership and your accountant services ten other car dealerships. It’s quite easy for him to give you a feel for what kind of budget you need for salaries, rents, insurance and other cost items.”
While business intelligence looks at data already out there, scenario planning looks at what could possibly affect the budget. Done properly, it creates a more robust budget with built-in contingency plans. Good scenario planning allows the business to identify trigger points as they go through the year. This helps them develop and implement an “agility plan” to mitigate those forces
Barolsky says scenario planning is done around various break points that will affect the company.
“Pure scenario planning is about thinking of your particular sector and the break points. It might be looking at a growth rate of say 3% or 4%; it might be looking at other things like legislative change.”
Examples might include contemplating the impact of the carbon tax or, in anticipation of a Coalition government, a change in workplace legislation.
Downes says companies need to have three scenarios. “My view is you have to do an expected case, a poorer case and the Armageddon case so you will be looking at the triggers for a down-and-out scenario as you go through the year,” he says.
“You need to know what happens if you are out by five or 10% on revenue or, worse still, on your margins.”
Downes tells of one client that had an export market representing about 25% of its revenue. When that vanished because of the dollar and competitive pressures, the company was prepared because it had anticipated something like that in its scenario planning. As a result, it was able to devote more resources to the Australian market and more than offset the lower overseas sales with a 30% increase in local sales.
Allsop says businesses need to build contingency plans into their budgets.
“It’s very hard to estimate what your costs and revenues are going to look like so you need to build some contingencies and be conservative,’’ he says.
“I always think a good budget will have an accurate but conservative projection of potential revenues and an accurate but conservative basis for understanding the costs. And then there is a contingency that needs to be factored in on a monthly basis just to cover those unforeseen events that always seem to happen.”
The post-mortem needs to be done regularly. In some sectors, such as retail, where there is a high turnover, it should be done weekly. In other sectors, there needs to be a monthly review. Obvious areas to review are expenditure, revenue and working capital, including how much of the revenue is still on credit or tied up with debtors.
Allsop says the budget should not be set in stone. “It’s important periodically, and it could be weekly or monthly, to look at how you’re performing against budget and make any modifications as required,’’ he says.
“If circumstances do change, you should be prepared to reforecast your budget.
“It’s always good to use a flexible document that is a guide to the business rather than a hard and fast set of rules.”
Downes says no budget delivers absolutely to the cent because it’s just a guess.
“People get hung up with going into enormous granular detail for not much great value add,’’ he says.
“The reality is if you hit your budget in 12 months’ time, it will be a sheer fluke if you hit within the dollar.
“The reality is we’re guessing what’s going to happen month-on-month. We are going to have climactic changes; we are going to have potentially political changes and possible regulatory changes
“We have to recognise that during the year, we may have to make some operational changes to deal with whatever comes in the business environment as we go through the year. It’s an important part of the process. We still need to be dynamic managers of the business.”
Downes says it comes down to some basic points: are you delivering the budget with a smaller gap between what’s in the budget and the actuals, and the speed at which the budget is put together.
Allsop explains it simply: “An indicator might be whether your monthly reporting aligns with your budget and forecasting. When there is not a lot of variation on a monthly basis between what you budgeted and what happens, I think that’s a good indicator that you’re on top of it.”
However, he adds a caveat.
“As soon as you think you’re good at it, it becomes a challenge again. As soon as you feel you’re on top of it, something can change.”
Andrew Sadauskas is a former journalist at SmartCompany and a former editor of TechCompany.
