By Michael C. Malota
Some business owners view budgets as an evil process creating little or no benefit to the department or organization. For CEO/entrepreneurs with that mentality, it might be a good idea to rethink your overall corporate communication and profit center strategy. Most managers however, understand the need to have budgets in place but adhering to them might be a different story. The most effective cost control initiatives will have a solid budget/forecast foundation tied to it which will also be the outcome of the pre-qualify process. This is where the budget process can be tied into an Enterprise Risk Management (ERM) process. Budgets, as defined differently from forecasts, are most effective with stable, mature organizations, where costs and revenue projections are easily predictable. Rarely do budgets work in an organization in growth mode, or startups, unless coupled with monthly monitoring of cash flows and cash ‘burn’ measurement. Forecasts, however, can be an integral part of the planning for startups and ERM process to be able to measure business spends and incomes monthly, quarterly and annually, and by monitoring cash burn and cash flow more exacting.
Here are some key cost control points to forecasting growth and budgeting. As some seem basic and trivial, many CEO/entrepreneurs would be surprised that these simple topics are not met:
• Create a budget for larger categorical spends with updated monthly/quarterly detailed line item forecasts associated with them, and continue to hold managers accountable with justifiable variances to actual results. This provides a good tracking tool to be measured against.
• Have budgets and forecasts formed at the detailed profit/cost center level by the responsible party with managers being responsible for their own spends.
• Each major spend or capital improvement spend should be directly measured against this simple idea: How will this spend improve revenues or create cost efficiencies? Measure each additional spend with revenue enhancement in mind and track accordingly.
• Each Capital item is to be benchmarked with an appropriate IRR or economic value added (EVA) metric not to exceed 1-2 years as breakeven.
• Tie your budget/forecast G&A spends into an overall goal of achieving at minimum 5% overall cost reduction each period for fixed costs and a separate benchmark for variable costs. Most budgets do not take this goal into effect; usually budgets will increase as a justified cost of living (COL) increase. Some COL % increase might be necessary where applicable; it does not have to be a justification for your budgets to increase. Try a reduction instead of a COL increase. In other words, if a 5% COL is imminent, incorporate it as part of an overall 10% reduction plan.
• On another note: keep new revenue projections in check with this conservative mantra in mind: Most money “falls down” when thrown out of a window, rarely does it fall ‘up’.
When putting together budgets and forecasts, it can be a good time to effectuate the timing of certain expedient cost control initiatives, however as mentioned, cost controls should be in the forefront of business ventures at all times.
Relationship with Vendors and Business Partners
Some CEO/CFO’s do not appreciate this fact: vendors are creditors. Like a bank, vendors are providing the company a loan, most of the time unsecured, with the promise to pay sometime in the future. Your company is obviously a vendor to someone else. Treat your key vendors like business partners, but at the same time manage your vendor base with cost competition in mind. Does it matter that you have a long term relationship with a vendor who has provided a product or service that has been reliable, but have found the same product or service at a discounted price elsewhere? Does it make sense to switch vendors? As I have experienced major cash liquidity issues during recession times, long-term vendor relationships can really pay off by extending terms and provide additional float. You, as a cash manager will be thankful that your long-term vendors will be there for the company if cash becomes short.
Keep your established vendors in check by continually looking for discounted pricing elsewhere, but maintaining a strong and open relationship by communicating your findings. Additionally, keep your vendors informed about the cost control initiatives that the enterprise has implemented. You will find that your long term vendors, or even vendors that want to be your long term partner will work with the business as both organizations wish to achieve the overall goal of a successful partnership. What about beating down your key long-term vendors? Yes, but with diplomacy and effective negotiation tactics where both parties win. What about vendors that provide a common service? Look for the best price and may the best vendor win.
Doesn’t Matter If During Good Economy or Recession
Most managers and executives wait for a liquidity event or recession as reason for cost reductions. While it certainly seems necessary at the time, it can fall far short of obtaining its desired goals, as unintended consequences such as a potential loss of an important customer, loss of employee morale, or even a loss of key people. Truly efficient and effective managers will have already implemented company-wide cost control measures that will take into consideration downturns in the business cycles or the overall economy. Plan now for the next potential economic downturn, and tie control initiatives into the strategic ERM plan already in place.
Providing Ultimate Benefits to Owners & Shareholders
Finally, each business owner, shareholder and Board Member will benefit and appreciate the company being lean and mean, even if it means potential sacrifices at the corporate or Board level. The business enterprise and its chief executives will obtain overall respect and integrity with an effective internal control structure that puts effective cost control measures tied to the existing ERM structure in the forefront. Always remember, it’s their money that they have trusted you with.
Michael C. Malota / Strovis CFO