Business Management


Last week we went over the Advantages of Budgeting, yet we did not discuss the number of serious disadvantages. This week’s article gives an overview of the general issues, while the following sections address the particular problems associated with capital budgeting, as well as the use of budgets within a command and control management system.

  • Inaccuracy. A budget is based on a set of assumptions that are generally not too far distant from the operating conditions under which it was formulated. If the business environment changes to any significant degree, then the company’s revenues or cost structure may change so radically that actual results will rapidly depart from the expectations delineated in the budget. This condition is a particular problem when there is a sudden economic downturn, since the budget authorizes a certain level of spending that is no longer supportable under a suddenly reduced revenue level. Unless management acts quickly to override the budget, managers will continue to spend under their original budgetary authorizations, thereby rupturing any possibility of earning a profit. Other conditions that can also cause results to vary suddenly from budgeted expectations include changes in interest rates, currency exchange rates, and commodity prices. 
  • Rigid decision making. The budgeting process only focuses the attention of the management team on strategy during the budget formulation period near the end of the fiscal year. For the rest of the year, there is no procedural commitment to revisit strategy. Thus, if there is a fundamental shift in the market just after a budget has been completed, there is no system in place to formally review the situation and make changes, thereby placing a company at a considerable disadvantage to its more nimble competitors.
  • Time required. It can be very time-consuming to create a budget, especially in a poorly-organized environment where many iterations of the budget may be required. The time involved is lower if there is a well-designed budgeting procedure in place, employees are accustomed to the process, and the company uses budgeting software. The work required can be more extensive if business conditions are constantly changing, which calls for repeated iterations of the budget model.
  • Gaming the system. An experienced manager may attempt to introduce budgetary slack, which involves deliberately reducing revenue estimates and increasing expense estimates, so that he can easily achieve favorable variances against the budget. This can be a serious problem, and requires considerable oversight to spot and eliminate.
  • Blame for outcomes. If a department does not achieve its budgeted results, the department man ager may blame any other departments that provide services to it for not having adequately supported his department.
  • Expense allocations. The budget may prescribe that certain amounts of overhead costs be allocated to various departments, and the managers of those departments may take issue with the allocation methods used. This is a particular problem when departments are not allowed to substitute services provided from within the company for lower-cost services that are available else where.
  • Use it or lose it. If a department is allowed a certain amount of expenditures and it does not appear that the department will spend all of  the funds during the budget period, the department manager may authorize excessive expenditures at the last minute, on the grounds that his budget manager may authorize excessive expenditures at the last minute, on the grounds that his budget tends to make managers believe that they are entitled to a certain amount of funding each year, irrespective of their actual need for the funds.
  • Only considers financial outcomes. The nature of the budget is numeric, so it tends to focus management attention on the quantitative aspects of a business; this usually means an intent focus on improving or maintaining profitability. In reality, customers do not care about the profits of a business – they will only buy from the company as long as they are receiving good service and well-constructed products at a fair price. Unfortunately, it is quite difficult to build these concepts into a budget, since they are qualitative in nature. Thus, the budgeting concept does not necessarily support the needs of customers.

The discussion of budgeting has cast serious doubts on the need for a detailed and rigorously-enforced budgeting system, especially one that integrates the budget model with bonus plans. Nonetheless, the decision to install a budget is up to the reader. In Budgeting: The Comprehensive Guide, Steven Bragg shows how to create a budget, whether there are variations on the traditional budgeting concept that may work better, and how to operate without any budget at all. The discussion also covers capital budgeting, flexible budgeting, zero-base budgeting, and all of the procedures, controls, and reports needed for a functioning budget system.

 

A budget is a document that forecasts the financial results and financial position of a business for one or more future periods. At a minimum, a budget contains an estimated income statement that describes anticipated financial results. A more complex budget also contains an estimated balance sheet, which contains the entity’s anticipated assets, liabilities, and equity positions at various points in time in the future.

A prime use of the budget is to serve as a performance baseline for the measurement of actual results. Budgets may also be linked to bonus plans in order to direct the activities of various company employees. A budget may also be used for both tax planning and treasury planning. Despite these valid uses, there are also a number of problems with budgeting that have given rise to a movement dedicated to the elimination of budgets.

The Advantages of Budgeting
Budgeting has been with us a long time, and is used by nearly every large company. They would not do so if there were not some perceived advantages to budgeting. These advantages include:

  • Planning orientation. The process of creating a budget takes management away from its short-term, day-to-day management of a business and forces it to think longer-term. This is the chief goal of budgeting, even if management does not succeed in meeting its goals as outlined in the budget – at least it is thinking about the company’s competitive and financial position and how to improve it.
  • Model scenarios. If a company is faced with a number of possible paths down which it can travel, you can create a set of budgets, each based on different scenarios, to estimate the financial results of each strategic direction.
  • Profitability review. It is easy to lose sight of where a company is making most of its money, during the scramble of day-to-day management. A properly structured budget points out which aspects of a business generate cash and which ones use it, which forces management to consider whether it should drop some parts of the business or expand in others. However, this advantage only applies to a budget sufficiently detailed to describe profits at the product, product line, or business unit level.
  • Assumptions review. The budgeting process forces management to think about why the company is in business, as well as its key assumptions about its business environment. A periodic re-evaluation of these issues may result in altered assumptions, which may in turn alter the way in which management decides to operate the business.
  • Performance evaluations. Senior management can tie bonuses or other incentives to how employees perform in comparison to the budget. The accounting department then creates budget versus actual reports to give employees feedback regarding how they are progressing toward their goals. This approach is most common with financial goals, though operational goals (such as reducing the scrap rate) can also be added. We will address a countervailing argument in the Command and Control System section later in this chapter.
  • Predict cash flows. Companies that are growing rapidly, have seasonal sales, or which have irregular sales patterns have a difficult time estimating how much cash they are likely to require in the near term, which results in periodic cash-related crises. A budget is useful for predicting cash flows in the short term, but yields increasingly unreliable results further into the future.
  • Cash allocation. There is only a limited amount of cash available to invest in fixed assets and working capital, and the budgeting process forces management to decide which assets are most worth investing in.
  • Cost reduction analysis. A company that has a strong system in place for continual cost reduction can use a budget to designate cost reduction targets that it wishes to pursue.
  • Shareholder communications. Large investors may want a benchmark against which they can measure the company’s progress. Even if a company chooses not to lend much credence to its own budget, it may still be valuable to construct a conservative budget to share with investors. The same argument holds true for lenders, who may want to see a budget versus actual results comparison from time to time.

These advantages may appear to be persuasive ones, and indeed have been sufficient for most companies to implement budgeting processes. However, there are also serious problems with budgets.

This article is an excerpt from Steven Bragg’s Budgeting: The Comprehensive Guide. To learn about budgeting, visit his course or join us for next week’s blog The Disadvantages of Budgeting.

As certain as death and taxes, accountants are sure to brush up against the law in the daily practice of their profession. “Every accountant needs a good working knowledge of the every-day legal matters that affect their clients financially,” says CPE Link instructor, Paul Jorgensen, founder of a Washington, DC law firm specializing in intellectual property and contract law. “A basic knowledge of the legal concepts involving contracts, intellectual property law, and the Internet makes you a more valuable financial professional. It helps you know when to enlist a lawyer and to recognize bad or wasteful lawyering,” says Jorgensen.

When he teaches accountants about basics of law, Jorgensen likes to start with contracts. Non-lawyers often think that contracts have to sound legal and the more legal-sounding the better. Nothing could be further from the truth, says Jorgensen. There’s a lot of bad legal writing out there and bad writing should send up red warning flags.

When it comes to the language of contracts, several rules apply. One is that “Simple words are best.” Start is better than commence. If is better than in the event that. Later is better than subsequent.

Another is “Always reject the passive voice.” Passive voice leaves too many questions, never a good thing in a contract.

Bad: “Use of Services shall be paid for by Tenant. Payments shall be received monthly for such Services.” Who uses the services? Who provides them? What are the payments for? Who receives them? How much are they?

Better: “Tenant will pay Landlord $65 for the Services on the third day of each month during the term of the contract.”

Once you cut through the bad legal writing, it’s easier to understand the essential contract provisions, not only in the contracts that accountants review for clients, but also in the contracts they make.

How often do you review contracts in which your client is a party? Do you always understand them?

Gearing up for Fall? Now is the perfect time to sit back, take a deep breath, and re-evaluate your tax business and how it’s performing for you.

CPE Link instructor Dominique Molina points out, “They say an apple a day keeps the doctor away,” and adds that a critical reassessment of the health of your tax business is just the apple you need for good financial health.

Molina points out just a few of the key questions practitioners should ask themselves:
• Do you know the value of a client?
• Do you have a dashboard to stay in touch with your business from anywhere?
• Have you created an individual, tailor-made business model?

Molina, co-founder and president of the American Institute of Certified Tax Coaches and an author and frequent lecturer, also urges practitioners to look below the surface at the “happiness factor” of their business.

That factor, she says, is made up of a range of variables that include “relationships, meaningful and important work, progress toward goals, and connecting to something larger than yourself.”

In the more nuts and bolts area of running a successful and satisfying business, Molina says practitioners should consider whether they “offer real value” and also whether the values of their customers have changed over time.

She urges practitioners to be more eclectic, broaden their scope and offer an array of services so that they serve varying needs of their clients.

And she says that to keep your financial house in order, make sure you always have a clear view of which of your services and products are the most popular.

If your experience with Facebook is limited to viewing pictures of your co-worker’s cats and snooping into your son’s party plans, you’re missing out on a major professional tool.

So says CPE Link instructor Garrett Wasny, a web productivity consultant who advises financial professionals on Internet discovery and social media.

“With so much of our professional and personal lives spent online,” Wasny says, “this knowledge is beyond relevant. It is the absolute core of how we gather information, make decisions and live our lives in today’s digital age.”

In fact, Wasny says, a thorough understanding of social media such as Facebook and micro-blogging site Twitter can be used to build your practice, network and career.

Facebook counts more than half the U.S. population among its users, and Wasny says there’s a lot to consider: How to register and control privacy, how accounting organizations use its services across the globe, and how to leverage its tools to boost online productivity, workflow, communication and collaboration.

Twitter is a free micro-blogging service that allows users to send and receive “tweets” — text-based posts of up to 140 characters. Those tweets can seem like the height of self-involvement (@kittykat Im goin to make that soup u talked about #whatieatfordinner).

However, Wasny points out that since its rollout in 2006, Twitter “has been embraced by everyone from Senator John McCain to Britney Spears and grabbed headlines all over the world.”

But with financial professionals “already overwhelmed with e-mails, overloaded with websites, and swamped with Facebook friends, do they really need one more Internet service in their professional and personal lives?” Wasny says the service can be used for business research, network building, marketing, recruitment, reputation management, idea sharing, regulation monitoring and much more.

Turns out social media isn’t just about how much beer your kid drank last night and what kittykat is having for dinner.

Considering the massive amounts of data businesses generate minute by minute – not to mention the urgency to go “green” for the sake of an increasingly fragile planet – the idea of “less paper” technologies become very attractive.

CPE Link instructor Roman Kepczyk says the digital realm provides practical ways to decrease an administrative department’s paper pile while upping its efficiency and security.

For example, most firms have adopted digital paystub delivery, but may be more hesitant to switch from integrating expense reimbursement with payroll. However, by doing so a firm can not only cut down on the paper it uses, but also cut down on bank transaction fees – a double win. And time can be saved that was formerly used schlepping back and forth to the bank by using remote check scan for deposits.

Kepczyk also suggests having personnel enter all expenses each day into Practice Management when they enter their time, rather than using separate Excel-based expense reports.

In teaching firms digital best practices, Kepczyk points to an “explosion of data and information” that can be handled by a corresponding expansion of connection options. Therefore, he stresses, system access and resiliency are an absolute must, as is reliable security.

Consider having firm owners log into a secure portal to read financial reports, rather than distributing them as PDFs or in paper format. One benefit to this practice, Kepczyk says, is that the digital controls triggered will leave an audit trial that shows exactly who viewed what, when.

And as a general rule, he says, everyone who works out of the office at least once per day and does not have home remote access to firm applications should have a a laptop as their only machine. He points to a study that shows 35 percent of firms utilize laptops for owners/managers as their only machine.

Kepczyk, who is director of consulting for Xcentric, works with accounting firms to hone their internal production processes. It’s a tough economy, he points out, and the time is right to focus on “improving your firm’s production processes and educating your personnel on best practices for this turnaround.”

In turbulent financial times such as these, many businesses find that simply maintaining the status quo is challenge enough. But for a far-sighted few, unusual times mean unusual opportunities.

CPE Link instructor Tom Tubergen
, the managing director of Mentoring Success Group LLC, points out that it’s necessary to not shy away from the “issue of gut-wrenching, strategic changes in direction” that can mean the difference between defeat and not only survival, but a flourishing survival.

We find this true in our personal lives as well. The loss of a job, end of a contract, illness of a spouse, college education of a child – the endless fluctuations of life mean that we must constantly be on our guard: watching where we need to retrench, seeing opportunities to expand, looking for ways to improve our lives.

Those who can’t move with the flow and adjust to changing life currents find themselves bogged down, going stagnant. But knowing which current to ride and which to avoid is a challenge.

Tubergen cites the famous Chinese general, Sun Tzu, who observed a timeless truth many centuries ago: “Strategy without tactics is the slowest route to victory. But tactics without strategy is simply the noise before defeat.”

Tubergen recalls that just a few years ago, “running a business was relatively straightforward. Buy low. Sell high. Join the local Chamber of Commerce. Carefully manage your expenses. The Internet, and the massive trends toward globalization in recent years changed all of that. Now we’re faced with an overwhelming amount of information about our business environment every day. Competitive threats emerge and disappear daily.”

What to do?

He advocates “leading yourself to lead others” as the perfect starting point. From there, he looks at ways to create the right strategy and manage “disruptive strategic change.” His insights have been put to use by accountants, attorneys, consultants and trade associations to help clients find that competitive advantage.

“Theory is great for academics and college professors,” Tubergen notes. “Where I operate, the rubber’s got to meet the road.”