Guest post from: Aaron Jaeger, President of Credo CFO
In recent corporate history, executives or change agents have frequently used the phrase: “Insanity is doing the same thing over and over again and expecting different results.” This is hyperbolic a call to challenge the norms; to innovate or deploy corrective action and otherwise improve. While there may be an unsaid groan from seasoned, salty veterans who anticipate a new TPS[1] report, process, or measurement tool, being satisfied with the status quo delivers mediocre results.
Dollars-to-donuts, most business owners, and key stakeholders who are in the throes of planning or budgeting cycles for the new year are thinking: “Now that 2020 is behind us, what does our business look like in 2021?” Every fiscal year gives a business a clean slate where the possibility of growth and profitability abound…with 2021 more significant than any other year in our lifetimes.
Through the finance function, constructing an effective operating plan with aligned revenue targets and budgets can unlock and enable financial success. As CFO, the burden of financial planning requires the broad charter of ‘owner’ and ‘leader,’ but great CFOs also challenge complacency in a quest to drive shareholder wealth.
Establishing Financial Objectives
As an opener, every organization has a different way to develop a financial objective and then cascade the details into a tracking method. A plan or budget becomes a target for an individual or group (department) with a varied time horizon. Each method requires some layer of time and thought to set the course for the future operations of the organization. Ultimately, the method is subject to leadership’s historical preference as well as the corporate culture or existing practices.
Each approach and technique have pros and cons when evaluated in a vacuum. In the broadest sense, companies will often establish a top-down objective that provides the team with a strategic direction. “Grow revenue by X% to yield Y% margins.” In some respects, this type of marching order delegates authority to those who live and breathe the business. Those stewards (business unit leaders, product line managers, department owners) have objectives to achieve a financial objective and it is incumbent upon them as to how they operationally solve.
Finding the Right Forecasts and Planning Approach
The executive view may be directionally correct, but may likely omit critical facts entering/exiting a planning period that prove to be unattainable or simply not sequenced with investment, cash flow, or the market. As we begin to evaluate for next year, leveraging a bottom-up approach can provide real substance to build 2021 targets based on the existing facts. Signed contracts (existing revenue streams), headcount-related expenditures, and facility expenses become predictable line items to project and form a foundation for a department’s individual budget.
As well, the longer a business has been in existence, history, and trends give rise to a predictive behavior or pattern. ‘Rolling forecasts’ are also used to complement a budget cycle, deploying an ongoing projection process that gives Management continuous visibility and the opportunity to make decisions to improve the financials of the future.
One major pitfall to avoid—exemplified in larger or governmental organizations—is assuming line items in a budget are ‘status quo’ for the simple reason that it was money spent last year. For example, if my division spent $50,000 on professional fees this year, a common assumption is that I will spend $50,000 next year. Additionally, savvy managers that know their business well can ‘put a thumb on the scale’ when establishing inputs to a budget to create a buffer and/or lower the bar for performance to attain bonuses.
An episode of ‘The Office’ illustrates this well. Oscar (the accountant) explains to Michael (manager) that they have a budget surplus. Michael must spend $4,300 by the end of the day or else the Scranton Branch loses that amount in the budget for the next year. A debate ensues about where to deploy this ‘found’ money. The climax of the episode culminates in Michael simply not spending any of the surplus. The result—A management bonus!
Aligning Budgets
One budgeting technique that can be used to deter waste is zero-based budgeting. As the name suggests, all of the expenses start at zero. Budgets then are justified, not by history, but based on the need to generate income and what it takes to run the business. By nature, the output generates a lean operating model when compared to other budgeting techniques that layer on existing spend as gospel and even tack on growth. Zero-based budgeting results in a focused execution strategy with lowered operating expenses
Zero-based budgets do have some shortfalls. The time it takes to reconstruct each expense, requiring a deep dive into the operations of the business is significant. Coordinating across people and functions to agree can be labor-intensive, but also highly political as individuals compete for the justification of resources. As well, zero-based budgeting can often be slanted towards a short-term objective as opposed to long-term planning objectives.
The clear pitfall of the zero-based budgeting approach is letting perfect get in the way of good. Rather, how much time am I willing to construct the perfect operating model versus actually growing the business? What I love about the zero-based budgeting approach is that the core tenant challenges the status quo by its very nature. Organizations lose sight of this as personal bias enters the forum, influenced by sentiment or relationship. The not-so-inconsequential question is: “Is this expenditure necessary for operations or is it a sacred cow[2]?”
Reducing Wasteful Expenditures
The reality is that any budgeting and related analysis takes time. Even in a relatively small company, columns of data require a discipline to apply financial savviness with knowing the underlying business. As a point of principle, having senior executives invest time in spreadsheets or modeling tools is poor, if not negative, return on investment.
Various practices can be implemented to challenge wasteful spending or, by contrast, under-funding no matter what planning methodology you subscribe to. In any event, two key ingredients are necessary: People and a mindset.
As with most anything we do, the first element starts with people. An experienced finance professional (or group of finance pros) develops various methods to identify projected gaps or oversights, such as year-over-year fluctuation, trend and ratio analysis, and other data manipulation that can uncover areas that can be trimmed or that need added investment. A good finance professional becomes data-driven to find correlation or data segmentation that offers insights and a logical process to construct a firm projection of the company’s financials without starving its ability to grow. Great finance professionals intimately understand the business and its stakeholders, challenging existing levels of spend, exacting an inquisitive nature to chart a course for execution with risk mitigation tactics built-in for long-term success.
The other area is a mindset or will to change. We’ve already discussed the zero-based budgeting methodology. Even in a traditional budget framework, we can set targets to cut for the operators of the business. Sometimes providing a mandate or a blank slate can prove to be a daunting take for lean and small organizations. A simple, pragmatic means can maintain a keen mindset to target expense reduction, less as an ‘elimination’ (an all-or-nothing objective), but that of an ‘alternative option.’ Rather, maintain the service, but get it done cheaper. This may mean that you do less of an activity so that your P*Q (Price times Quantity) declines. Or, it may likely mean that you get the ‘P’ part of the equation to drop.
Across the board, companies get set in their ways. Whether it is a staffing decision, a facility, or something as trivial as a payroll processing company, “Because we always have…,” is a convenient answer because no one has asked. Often, I will talk to a client or a colleague and the answers become semi-embarrassing. “We use vendor A because this was the vendor that won our contract back in 1995.”
As vendors exact a CPI increase and diminished service, the squeeze on margins becomes a real, uphill battle. As well, there is rarely a silver bullet that makes transitioning from a vendor result pain-free. Beyond the research and selecting a new vendor, “Ripping and replacing” existing vendors may yield the cost savings desired, but the quality may decline.
One such vendor that makes a savvy alternative is Stax. If a company processes most of its revenue via credit cards, the processing fee can create a drag on the entire business’s profitability. Stax offers a solution that reduces the average credit card processing fee to produce real savings, in many cases Stax can save over 1% (as a percentage of revenue). As well, their solutions do not create a drop-off from other credit card processors; switching to Stax occurs with nominal interruption to operations, often transitioning that same day. There are very few solutions that can boast a pain-free lift of this nature.
In Summary
Whether $1M or $1B or somewhere in-between, a strategic CFO can create enormous value by working shoulder-to-shoulder with a CEO or owner(s) to execute a vision. Optimizing shareholder wealth should be a mantra that is repeated before, during, and after any planning cycle.
When it comes to spending, the CFO plays a critical role in holding the purse strings and exacting a fiduciary discipline. For instance, the CFO may play the part of ‘Chainsaw Larry CFO’ (reducing bloated payrolls by laying off and reorganizing human capital assets to get back to profitability.) In what we’ve discussed today, the CFO mindset is that we trade our chainsaw for a hunter’s knife. Our target is to trim fat in a more intentional and precise manner. We are looking to thin the herd…and find the sacred cows…Let the hunt begin!
Quick FAQs about Aligning your Budget
Q: What does the phrase “Insanity is doing the same thing over and over again and expecting different results” mean in the context of budgeting and expenditures?
This phrase is often used to emphasize the need for businesses to innovate and make changes to their standard operating procedures, including their budgeting and expenditure practices. If a business continues to follow the same budgeting practices and expects different financial outcomes, it may be considered an ‘insanity’. It implies that businesses should look at different ways of budgeting and controlling expenditures to improve financial results.
Q: What is the role of a CFO in financial planning and reducing wasteful expenditures?
The CFO plays a critical role in financial planning by establishing financial objectives, constructing effective operating plans, and setting aligned revenue targets and budgets. They challenge complacency and drive change to improve financial success. In terms of reducing wasteful expenditures, the CFO holds a fiduciary responsibility to ensure money is spent wisely and effectively. They may employ techniques such as zero-based budgeting to trim unnecessary costs and optimize financial resources.
Q: What is zero-based budgeting and how does it help in reducing wasteful expenditures?
Zero-based budgeting is a method where all expenses start at zero at the beginning of the budgeting period. Every expenditure needs to be justified based on the need to generate income and what it takes to run the business. This approach discourages wasteful spending by forcing a review of all expenses, rather than simply carrying over the previous year’s budget. However, it may be more time-consuming and requires a deep understanding of the business operations.
Q: What are the potential pitfalls of zero-based budgeting?
While zero-based budgeting can help reduce wasteful expenditures, it can be time-consuming as it requires a thorough review of every expense. It can also be politically challenging as different departments or individuals compete for resources. Additionally, zero-based budgeting may focus more on short-term objectives and overlook long-term planning needs.
Q: What is the concept of a ‘sacred cow’ in the context of budgeting?
In budgeting, a ‘sacred cow’ refers to an expenditure that is considered untouchable and beyond criticism, regardless of the state of business operations. It represents spending that is held onto due to tradition, sentiment, or perceived importance to corporate culture, even if it may not be financially justifiable.
Q: How can companies challenge wasteful spending?
Companies can challenge wasteful spending by implementing various practices such as zero-based budgeting, year-over-year fluctuation analysis, trend and ratio analysis, and other data manipulation techniques. They can also encourage a mindset of change and challenge the status quo. Additionally, they can explore alternative options for services and vendors to reduce costs without compromising on quality.
Q: How can vendor selection impact a company’s budget and expenditures?
Vendor selection can significantly impact a company’s budget and expenditures. If a vendor increases their prices or reduces their service quality over time, it can affect the company’s margins. On the other hand, switching to a more cost-effective vendor, like Stax for credit card processing, can result in substantial savings. However, companies should also consider potential disruptions or quality changes that might come with switching vendors.
Q: What is the role of a strategic CFO in a company?
A strategic CFO works closely with the CEO or owner(s) to help execute the company’s vision. They play a critical role in financial planning and control, seeking to optimize shareholder wealth. They may take on various roles, such as ‘Chainsaw Larry CFO’, cutting costs and reorganizing resources, or act as a ‘hunter’, trimming unnecessary expenditures in a more precise and intentional manner.
[1] TPS is a reference to a mundane or tedious report that has little to no worth.
[2] Sacred Cow – An idiom that considers an idea, something, or someone as beyond questioning or criticism. In context, an expenditure that is untouchable regardless of business operations. A practical sacred cow example: A company having dire cash flow issues refuses to suspend free, Friday employee lunches as it is viewed as part of their corporate culture. (News flash, if you go out of business, there is no culture… much less no free lunch!)
