Handbook of Budgetingby Robert Rachlin (Editor), Sweeny H. W. Allen
Without clearly outlined budgets, corporations are unable to predict profits or losses or create plans for the future. This handbook shows controllers and budget directors how to create any style of budget, from the traditional approach to the cutting-edge, activity-based approach. No other management tool provides the operational direction that a well-planned
Without clearly outlined budgets, corporations are unable to predict profits or losses or create plans for the future. This handbook shows controllers and budget directors how to create any style of budget, from the traditional approach to the cutting-edge, activity-based approach. No other management tool provides the operational direction that a well-planned budget does, and no other book provides such a complete guide to preparation, presentation, analysis, and effective use.
This book is supplemented annually.
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THE RELATIONSHIP BETWEEN STRATEGIC PLANNING AND THE BUDGETING PROCESS (NEW)
Jeffrey L. Bass, MA, MPA, Principal
Margolin, Winer & Evens, LLP
(Please note: Exhibits and any other illustrations mentioned in the following text refer to the print edition of this work, and are not reproduced here.)
To fully understand and appreciate the functional relationship between strategic planning and budgeting, it is important to understand the purposes of strategic planning. For early-stage companies, business plans are typically seen as marketing tools in the capital formation process. As the company matures, strategic planning evolves into a process of assessing and responding to industry change. However, it may still be used to raise capital. As the company matures to Fortune 1000-100 status, the strategic planning process will likely become an institutionalized function designed to dynamically direct and control growth and direction. And yes, it may still be used to raise capital.
This chapter examines the strategic planning process from the perspective of organizational, managerial, operational, marketing, and financial impacts. The role of budgeting in planning as well as in plan implementation and monitoring is discussed.
2A.2 HOW TO PLAN.
Some years ago I had the privilege of teaching an entrepreneurial management course at Queens College of the City University of New York. Invariably, whenever I would ask why it was important to strategically plan for a company's growth and development, the answer would be, "To raise money." Interestingly, I would often receive the same response to this question from well-educated, seasoned CEOs and CFOs of publicly held companies that were performing marginally at best.
Strategic planning must not be viewed merely as an expedient way to raising capital. First of all, sophisticated capital providers and their professional representatives will quickly understand and dismiss a business plan born of such reasoning. Perhaps more importantly, the management team with such a limited view denies itself the opportunity to objectively and methodically manage and control the company's growth and development. By requiring the definition of business objectives and identification of realistic market, operational, and financial targets, the strategic planning process becomes an important weapon in management's arsenal. Actual performance can be measured against targets established through the planning process. Variations from these targets can be addressed and corrective actions taken--including, perhaps, modifying the strategic business plan--without resorting to crisis management. Impacts on revenues, cash flow, and profitability of product modification or new product development can be carefully assessed and adjusted. Changes in industry direction or consumer preference can be more easily monitored and addressed in a timely fashion so as to assure a sustained competitive, if not competitively advantaged, market position.
The strategic planning process also defines the need for and scheduled deployment of various resources and technologies. If undertaken objectively (i.e., in an egoless environment), the strategic planning process defines the talents and skills of management needed to assure successful company growth. Finally, the planning process facilitates the termination of financing requirements and financial performance.
In short, growing a company is like embarking on a trip to an unfamiliar destination. We could travel blindly, asking directions along the way, and hoping that we are not being misdirected. If we arrive at our destination, it may be too late for it to be meaningful. Alternatively, we can research our destination to assure that it is the place we want to be. We can plot our course, understand the directions and time and cost of travel alternatives, and arrive at our destination before the sun sets. This is how prudent business owners and managers plan: by developing a road map to set the course for their companies' successful growth and development.
By the way, a business plan resulting from such an objective strategic planning process can more successfully be used as a capital-raising document, if for no other reason than it will convey to the capital provider the seriousness and maturity of the management team.
2A.3 FOR WHOM THE PLAN IS DESIGNED--THE AUDIENCE.
The conventional belief is that because a strategic business plan is prepared to satisfy the assumed requirements of capital providers, these individuals or entities must be the most important readers of the document. However, the strategic business plan should not be formulated as a capital-raising document, so it follows that capital providers should not be viewed as the primary audience of the plan document. Indeed, as the strategic plan should be a product of a deliberate, methodical, and objective planning process, it stands to reason that the most important users are the business owner and managers. These individuals should use the plan as the operating tool it was designed to be.
A properly formulated strategic business plan assesses management and organization requirements and includes functional job descriptions and tables of organization. Therefore, the plan could also be of value to attorneys drafting shareholder agreements, employment contracts, and private placement memoranda, among other documents. In addition, the company's accountants or compensation planners may find the business plan useful in helping management to formulate competitively advantaged compensation programs to attract and retain the highly qualified key employees needed by the company to achieve its stated business objectives.
Suppliers and large customers often like to review a company's business plan, to find some assurance that they can expect to enjoy beneficial long-term relationships with the company. Finally, capital providers are, of course, important readers of the strategic business plan.
2A.4 STRATEGIC BUSINESS PLANNING AND ITS ROLE IN BUDGETING.
Budgets are documents that reflect management's best estimate of revenues and expenses at a future time. In a mature company (for the purposes of this discussion, a mature company is defined as one with at least one year of operating history), management has the luxury of experience and history. The older the company, the more confident management can be in using history as a component in the budget-making process. It can, at least in part, base its budget on the company's past financial performance. Understandably, a startup company's management does not have the tool of history to work with. Formulating a budget for this group of managers is tantamount to sticking a wet thumb to the wind. Interestingly, what both sets of managers have in common is the unknown. How well future events are factored into the budget process will determine not only the efficacy of the resulting budget and its reliability as a financial and operating tool, but will also minimize the incidence of "surprises" such as market or technological changes. Such modifications in the business dynamic could cause substantial deviations from budget and, importantly, could harm the company.
No one can, with 100% confidence, predict the future, regardless of the reliability of the data we use. However, by engaging in a methodical and objective process of strategic planning, management of any size company can at least afford itself the ability to understand and factor into the analyses parameters of change. An institutionalized program of strategic business planning requires management to regularly assess the market within the context of the company's business objectives, product mix, marketing strategy, research and development program, management and organization structure, operations, and budget. Consequently, the effect(s) of market fluctuations on all functional areas of the organization can easily be analyzed. Budgets can be modified to reflect the new reality and corrective management actions, if necessary, can be taken in a calm and deliberate manner.
What is important to understand is that budgeting is a component and actually a product of strategic planning. If we embrace the process of strategic planning and accept the premise that it should be institutionalized and repetitive, we can better understand its relationship to budget making, monitoring, and implementation.
2A.5 PLANNING DIFFERENCES BETWEEN SMALL, MEDIUM, AND LARGE ORGANIZATIONS.
If we lived in Utopia, all businesses, regardless of size, would have institutionalized strategic planning programs. In the real world we reside in, this will never be the case except, perhaps, among Fortune 50 or 100 companies that have whole departments dedicated to strategic planning. AT& T and IBM are two examples. At the opposite end of the spectrum, we can hardly expect the neighborhood dry cleaner or grocer to do any kind of formalized planning. However, once again, all businesses are united by the common thread of market change and very often by internal threats or opportunities as well. Their ability to anticipate and respond to such changes will affect their competitive position, profitability, and cash flow and, in the case of the public company, stock price and market capitalization. Although the neighborhood dry cleaner will not likely engage in formal strategic planning, he or she must nevertheless be sensitive to the local competitive environment, consumer preferences and expectations, demographic changes, and technological changes within the industry. It is wise for such a small business person to be alert to these elements to assure, as best possible, business continuity and profitability. The only instance in which this size business would ever be asked for a business plan including detailed financial projections would be to satisfy the requirements for a loan application, particularly one that carries a guarantee of the United States Small Business Administration or other government agency or program.
Consider, though, the dry cleaner who has a good understanding of the market. This person believes, perhaps, that the days of the single-store neighborhood dry cleaner are numbered. Due to the cleaner's entrepreneurial spirit, the company embarks on a program to consolidate neighborhood-based dry cleaners through strategic acquisition. The plan also calls for the creation of a central cleaning facility to service the acquired stores and achieve important economies of scale. Because dry cleaning is a cash business, the dry cleaner needs financial controls and systems to assure the honesty of cash flow. The strategy is to acquire underperforming entities and improve them through various capital improvements and management changes. To realize the plan, this person has to identify suitable acquisition targets, understand their respective markets, and develop an acquisition model. The cleaner will also need a definitive assessment of financial requirements and performance, as well as an understanding of how the requisite financing will be obtained and used. In short, this entrepreneur must engage in a strategic planning process to properly structure a growing acquisition-and-operating company that will require significant financing. Though the immediate motivation for such planning may be to secure capital, an objectively prepared strategic business plan will enable the entrepreneur to better manage invested proceeds and measure acquisition timing and actual store performance against targets.
Several years go by and the dry cleaning company now owns several thousand dry cleaning stores throughout the United States. Its stock is publicly traded on a major exchange. Earnings are increasing period for period and the P/E ratio remains strong. The company is the clear leader in its industry. However, its ever-vigilant Strategic Planning Department detects potential internal and external threats to the company's long-term success: on the one hand, its labor force is agitated over what they believe to be noncompetitive wages and benefits. In addition, a new and apparently well-financed dry cleaning Internet site, providing 24-hour pickup and delivery at very competitive prices, is introduced with considerable fanfare and industry analyst excitement.
Having reviewed the analyses conducted by staff, the Director of Strategic Planning confers with the company's Vice President of Human Resources and Information Technology Officer to formulate workable responses to these threats. The director then meets with the company's president, chief financial officer, and chief operating officer and recommends the timely implementation of a new compensation and benefits program, as well as changes in human resources policies and procedures. Also recommended is a global expansion program, as well as modification of the company's Internet site to offer 24-hour pickup and delivery utilizing the company's vast network of stores. When asked by the CFO to justify her recommendations, the Director of Strategic Planning produces long-range analyses indicating steady and growing erosion of market share and dramatic escalation of labor costs if these actions are not implemented. In addition, the director provides analyses indicating that if these strategies are implemented, EPS and market capitalization will continue to rise. The director produces an implementation schedule linked to a detailed budget to show the effects of implementation. The CEO, CFO, and COO confer further with the Director of Strategic Planning. They make some modifications to the plan, but approve it almost as recommended. The company's board of directors meets to review the plan. After considerable deliberation, they approve implementation. Subsequently, industry analysts notified of the change react positively, believing that the company will maintain and expand its market share. Several upgrade the company's stock to a "strong buy." The Strategic Planning Department will continually monitor the effects of implementation against plan and budget forecasts, even as staff maintain their vigilant watch over internal and external events that could affect the company's good health.
From the startup to the stock market darling, all companies must strategically plan. The method and intensity of planning is a function only of stage of development.
2A.6 COMPONENTS OF STRATEGIC PLANNING
(a) Definition of Business Objectives. As the hackneyed Chinese proverb goes, "A journey of one thousand miles begins with the first step." When applied to strategic planning, perhaps the proverb could be phrased, "The road map to success begins with the definition of business objectives." The statement of business objectives establishes the direction the company will take to achieve the growth that its owners and managers believe it is capable of. The business objectives lay out clear expectations of what can be accomplished within a defined period. This statement is the reference point of the company's marketing strategy, organization and management development, operations growth, and financial performance. It begins the business planning process and sets the tone and direction of the business and its plan.
The typical time period covered by a business plan is three to five years (three years is a lot more realistic). Therefore, strategic business planning should begin with the definition of an overall business objective, also known as a mission statement. The mission statement basically memorializes the purposes of the business's existence. The mission statement often discusses how the company, through its products and/or services, will succeed by filling a void in the market, improving upon current products or technologies, or creating demand. The mission statement should continue with a discussion of the expected management philosophy and style of the company and how these are consistent with success.
Upon completion of the mission statement, the next task is to define short-term, interim, and long-term objectives. If planning for a three-year time period, these can often be linked to the first, second, and third years, respectively.
(b) Critical Success Factors. Critical success factors can be viewed as milestones that must be reached if the company's stated business objectives are to be achieved. For example, a short-term objective of an early-stage company may be to obtain required financing. A critical success factor in accomplishing this objective would be to complete a strategic business plan. A later-stage company may have an objective to expand geographically. In this instance, critical success factors could include completion of detailed market analyses of targeted areas; acquisition of office, manufacturing, or warehouse space; completion of capital improvements; and hiring of required human resources. An understandable business objective of a public company would be (and should always be) to increase shareholder value. Critical success factors would include achieving cost reductions of some specified amount, revenue enhancement through introduction of new products by specified dates and completion of strategic acquisitions within stated time frames.
Critical success factors are important because they constitute the mechanism through which a strategic business plan is implemented and monitored. They facilitate formulation of action plans which in turn are linked to project budgets. (See further discussion on this in Section 2A.10.)
2A.7 MANAGEMENT AND ORGANIZATION
(a) Management. Many of us are familiar with the real estate professional's admonition that the three most important considerations in purchasing real property, of any type, are "location, location location." Ask an astute investor to identify the most important criteria of an investment decision and he or she will tell you, "management, management, management."
A company can have a great product or family of products with a very accepting market. However, if the assembled management team is ill suited to bring the products to market and/or to do so in a cost-efficient manner, it is highly unlikely that they will attract the capital required by the company. This is as true of the mature company as it is of the startup. In the case of the later-stage company, the founding management team may not have the skill or depth of experience needed to grow the entity to the next level. Therefore, obtaining financing to fuel future growth may range from difficult to impossible.
As strategic business planning is an objective process, it stands to reason that the management team must be true to the process and to itself. Very simply, founders or later-stage company managers must soberly assess whether they individually and collectively possess that combination of skills and experience needed to achieve the company's business objectives. Clearly, it is in management's selfish interests to do this soul searching, because both present-day income and future wealth accumulation depend on the outcome of this analysis.
The impact of this analysis on budget making may be obvious: If additions to the management team are necessary, cash flows will be affected by virtue of the impact on general and administrative expenses. Line items affected would include:
- Executive compensation
- Payroll taxes
- Furniture and fixtures
- Leasehold improvements
Why rent furniture and fixtures and leasehold improvements? Simple: Each manager hired, depending on level of responsibility, will require work space. This can range from a cubicle to a thousand-square-foot office with conference facilities. These offices may have to be built, and clearly they have to be furnished and equipped with computers and other office necessities. If additional space is required and is available in the same facility, rent will increase. If new space is needed, decisions will have to be made regarding buy/lease alternatives in terms of impact on earnings and cash flow.
Of course, higher level executives will likely command superior compensation and benefits programs, which could include deferred compensation, bonuses, profit sharing, and use of company-leased automobiles. Obviously, these items have budget implications as well.
(b) Organization. No less important to the company's success are its human resources below the executive management level. Sound strategic planning should not only include analyses of human resource requirements at every functional level, but should also define organizational culture and management staff relations. A table of organization graphically depicts hierarchical reporting relationships. A functional table of organization also includes brief descriptions of responsibilities for each position included in the organization structure. These charts also identify the numbers of persons needed per position.
Although the tangible implications of human resource needs analysis on budget making are obvious, less clear is the impact on the budget and company success of the organizational culture. Unfortunately, some managers neglect consideration of this important element in human resource planning. Today's businesses not only emphasize and expect a high level of work ethic, solid performance, and productivity, but also increasingly are providing workplace attributes that respond to workers' professional, physical, social, and emotional needs. Hierarchical reporting is necessary for supervision of less experienced workers by more experienced ones, but many organizations today also have some form of participative management system which allows workers at every level to provide input to management decision making.
In the early 1980s, the New York City Department of Sanitation embarked on a radical program to change its solid waste refuse collection system. It proposed to eliminate one worker from a then-conventional three-person truck crew. It also proposed to extend collection routes by approximately one-third, meaning that the two remaining workers would have to work 50% more. Understandably, the union representing the workers was vehemently opposed to such actions. However, through labor management committees, workers participated in a process of route design, productivity target formulation, and collection truck design. The result was deployment of a new collection system using two-member truck crews operating radically different trucks along longer routes. Notably, not one worker was laid off, New York City streets got demonstrably cleaner, and workers who met productivity targets received incremental shift differential pay. New York City's operating budget was reduced by more than $100 million. (The author was Director of Operations Planning for the New York City Department of Sanitation at the time.)
Today, companies also provide day care, a variety of insurance and retirement benefits, flextime, and so forth. Though all these programs affect budget making, they nevertheless create a more cohesive and productive work environment with likely positive implications for the bottom line.
2A.8 MARKET ANALYSIS
(a) Total Available Market. The total available market refers to the overall industry in which a company participates. An understanding of this industry--from consumer preferences through the influence of technological change to competitive environment, profit, and pricing--is absolutely necessary to determine if a business should be started or continued in a particular industry. These analyses can and should be conducted regularly to afford companies at any stage of development the benefit of current market intelligence.
(b) Segment Analysis. Segment analysis is simply a refinement of an analysis of the industry. For example, the wireless communications industry includes everything from cellular phones through handheld personal data systems. But what if a company did nothing but distribute wireless paging systems? Though management should certainly have intelligence about the total available market, it really has to focus on that segment of the industry focused on wireless pagers. The same demographic, competitive, supplier, pricing, and profit analyses that will be conducted at the industry level will have to be more concentrated here. The distributor will have to know the segment very well to develop and sustain even a competitive--let alone a competitively advantaged--market position.
Total available market and segment analyses are not mutually exclusive. Indeed, there are compelling reasons to coordinate the two. First, every company, as part of its strategic planning process, must assess internal and external Strengths, Weaknesses, Opportunities, and Threats (SWOT analyses). Without getting into a very detailed discussion, suffice it to say that SWOT analysis defines the organization's strengths as well as its vulnerabilities. Armed with this information, management can more decisively and objectively formulate strategies and implementation actions to shore up the weak areas and capitalize on the strong ones. A thorough understanding of the market facilitates this process. In the example of the wireless pager distributor, technological changes coupled with consumer preferences suggest a broader acceptance of cellular telephones as a preferred means of communicating. Indeed, many cell phones now feature paging, voice mail, and caller ID capabilities. The distributor is one of the leaders in the industry and has a highly motivated and well-compensated sales force. Management makes the strategic decision to create a cell phone division. Not only will this action result in mitigating any falloff in pager sales, but it also would likely constitute a new growth area for the company.
Market research need not be a daunting task. For the startup, most local area colleges have good libraries and business professors and students eager to assist with the research. The cost for such services is usually very nominal. Of course, entrepreneurs should immerse themselves in the process as much as possible, so that they can benefit from hands-on knowledge of the market.
Later-stage companies could purchase detailed and longer-range analyses from highly reputable market research firms. A number of these enable subscribers to access vast databases online.
Publicly held companies should have in-house market research capability. The rationale for this is simple: Financial institutions making a market in the company's stock have such a capability, in the persons of industry analysts. In addition to facilitating responsive management decision making in a dynamic environment, current data enables management to have the same body of knowledge as the analysts and to better fashion preemptive financial public relations that could actually influence the analysts' thinking.
2A.9 FORMULATION OF MARKETING STRATEGIES.
The formulation and implementation of marketing strategies have obvious implications for budget making. The more sophisticated the marketing strategies and supporting programs, the more costly they will be to implement. Simple preparation and distribution of product literature will incur one level of cost. A more complex strategy of establishing a competitively advantaged market position (for example, through aggressive pricing, opening geographically dispersed sales offices, active trade show participation, and multimedia ad campaigns) will have a significantly different impact on projected revenues, general and administrative expenses, profit margins, cash flows, and ultimately, net earnings. The latter end of the spectrum is not reserved solely for later-stage companies. Startup technology companies, for example, not only have to develop product literature in advance of going to market, they also often have to be present at trade shows and advertise in strategically selected journals.
The formulation of sound and realistic marketing strategies is critical because it constitutes the major vehicle for attaining the organization's strategic business objectives. Consequently, formulated strategies must respond to analyzed market conditions and opportunities. Whereas too aggressive a marketing program may be injurious to the company, very often a timid marketing program can have even more dire consequences, including erosion of lead time and dilution of competitive advantage. Therefore, market strategy formulation should not be constrained by budget making. Indeed, it is wise to let the marketing strategies dictate budget requirements. It is always easier to "shape" marketing strategies after they have been formulated and analyzed for budget impact. Some careful pruning of too rich a program can be made. However, if too much scaling back has to be done, a wholesale reassessment of the market, business objectives, and marketing strategies must be initiated. In this respect, marketing strategy formulation constitutes the first "traffic signal." It either confirms or rejects the alignment of market data, strategic business objectives, and projected financial requirements and performance.
2A.10 OPERATIONS ANALYSIS
(a) Implementation and Monitoring. Careful monitoring of market strategy and operations plan implementation is important, not only from a budgetary perspective but also, significantly, from the perspective of attaining the organization's business objectives. If it is important for the company to actively participate in four trade shows in a given time frame, but the company only participates in three, there may be some cost savings--but the company's competitive position may be endangered. Alternatively, office or plant rental costs may be significantly higher than originally projected. However, this budgetary "hit" may be offset by the property's location or the perceived strategic compatibility of other tenants. Therefore, an important component of implementation of a strategic business plan is monitoring timeliness, as well as the actual versus projected costs of carrying out the plan. Discrete tasks and expected outcomes, assignment of task or project responsibility, task completion timelines, budgeted resources, and variance from budget reporting are all ingredients of sound plan implementation and monitoring. Exhibit 2A.1 is a suggested task/output work plan. Exhibit 2A.2 expands this plan to a monitoring and reporting tool.
Because human resources is responsible for the plan's success, it is important that all the appropriate people be involved in the strategic planning process. For the startup, these would likely be the founders of the company. For the later-stage, more complex, and perhaps publicly held corporation, participants could include various officers of the entity (e.g., CEO, COO, CFO, CIO, Executive VP, Marketing and Sales VP[s], etc.) and lower-level managerial or professional staff. The same individuals who formulate the strategic business plan should also have responsibility for its implementation, monitoring, and modification if this becomes necessary. Each responsible individual must have a thorough understanding of his or her responsibilities, deliverable due dates, and the implications of his or her assignment on the work of other team members and on the organization's attainment of its business objectives. Although Exhibits 2A.1 and 2A.2 facilitate this process, their usefulness will be diluted if the implementation team (which could also be thought of as a project team) does not have the discipline to meet regularly and take its responsibilities seriously. Indeed, the entire strategic planning process will have been for naught if the same commitment to planning is not carried over to implementation and monitoring the success of implementation.
(b) Selling the Plan. At the beginning of this chapter, we reviewed the potential audience or readership of the strategic business plan. The most important user of the plan is the management team itself, so the first selling effort must be of the strategic planning process. The onus is on executive management to communicate the benefits of strategic planning to these others who will be members of the planning team. Executive management of companies that have embraced contemporary management styles and techniques will likely have an easier time than their counterparts at companies that still support strictly top-down management decision making.
Other readers of the plan, including capital providers, suppliers, customers, attorneys, and so on, must get a sense that the management is sincere and can propel the company to at least the performance levels defined in the strategic business plan document. Even with an established company, management will have to convince outsiders that they have the wherewithal to continue the entity's growth and development. For startups, the task is clearly more formidable. In either case, an objective strategic planning process resulting in a realistic, no-holds-barred business plan will go a long way to convince readers of the plan document of management's seriousness and its capability of sustaining and growing the company in a profitable fashion.
Strategic business planning is not easy. It requires commitment not only to the work of planning, implementation, and monitoring, but also--more importantly--to the objectivity that is the essential ingredient of the process. Unless this commitment is there, regardless of the truths that may be born of objectivity (e.g., need for changes in management team composition or responsibilities), the plan will be useless. Not only will it not suffice as a capital-raising document, but it will also not serve as the "road map" to guide management for continued growth and development of the company. To the contrary, subjective planning will lead management astray and could actually result in underperformance at best, and the company's demise at worst.
SOURCES AND SUGGESTED REFERENCES
Banham, Russ. "The Revolution in Planning." CFO August 1999, p. 47.
Berry, Tim. CPA's Guide to Developing Effective Business Plans. San Diego, CA: Harcourt Brace, 1999.
Fogg, C. Davis. Implementing Your Strategic Plan. New York, NY: Amacom, 1999.
Handbook of Business Strategy. New York, NY: Faulkner & Gray, updated annually.
Journal of Business Strategy. New York, NY: Faulkner & Gray, semi-monthly.
Strategy & Business. New York, NY: Booz, Allen & Hamilton, quarterly.
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