More than Numbers: Budgets Offer Roadmap for Success

Every year, companies face the often laborious process of developing an annual budget or similar financial plan. However, not all companies successfully implement that plan or use it as an effective business tool. The constant fluctuation of today’s economy can lead to a feeling that the budgeting process is pointless and that actual expenses will be nowhere close to the budget. These sentiments can leave everyone in the company feeling demoralized.

We advocate a different view. Budgets should not be viewed as a static snapshot of a company’s expected annual performance but should be a flexible projection of expected performance, detailing critical financial and nonfinancial metrics that stakeholders use for managing the business.

In today’s unpredictable economy, estimating future revenues and expenses can be construed as “mission impossible.” However, it is important to understand the interrelationships of key variables in order to predict how fluctuations in each variable might impact profitability, cash flows, or compliance with critical covenants.  For example, rather than projecting total cost of goods sold, a distributor might want to determine how much of cost of goods sold is driven by fuel costs and base budgets on specific fuel cost assumptions.  By doing this, management can monitor changes in fuel costs, assess the impact on critical measures of financial performance, and quickly reforecast in light of changes.  Additionally, by creating budgets in this manner, the budgeting process can include the development of alternative scenarios and facilitate the creation of contingency plans to minimize business risk.

By having the necessary tools, management will be able to quickly address the impact of potential changes in:

  • Projected taxable income
  • Cash flows
  • The need to finance operations or capital expenditures through lending arrangements
  • The company’s ability to meet third-party covenants or expectations
  • Projected shareholder distributions

A budget or financial plan may take many shapes or forms, but it always should serve as a roadmap for the achievement of critical objectives, enable management to make more proactive decisions, and clearly communicate management and owners’ performance expectations to the entire organization.

 

Brian J. Sharkey can be reached at Email or 215.441.4600.