Sunday, February 26, 2012

Bud don’t know Jack!

More recently than not, through the demands of my work, I have questioned if dementia has set in, as I cannot recall if my training in business and finance included studies in clairvoyance. At recent roundtables of financial professionals, the buzz of dialogue continues to focus on matters of budgeting and reporting. Through these moments of altered existence, I wonder if these people are really listening to themselves discuss the lunacy of budgeting.

I do vividly recall my accounting training on different budgeting models; how and when to apply and the value of the outcomes. What I don’t recall is how an accounting designation allows me to predict the future. Budgets are in essence a prediction of the future. The amazing part of this logic is management seeks budgets with tremendous degrees of detail. There are so many flaws with this level of thinking that it is borders on stupidity. An accountant is no better able to predict the financial position of an organization 10 months out as a meteorologist is able to predict the weather of Chicago on November 28, 2012!

The budgeting process is so ingrained in business that it is the cornerstone of management and the finance team. It consumes a tremendous amount of time to develop and it gives license to management to bayonet those who do not meet ‘the target’. Why do we still rely so heavily on The Budget? I feel the budget is the language of business because ‘we have always done it that way’ and no one is willing to venture into virgin territory, seeking a better way.

The most humorous part of budgeting is that one is able to create one’s own reality. This is best presented in the foundation of the budget – the top line or revenue number. During a recent engagement with an east coast aggregate supplier, I was introduced to their crystal ball mentality. The goal of the parent company was to increase the bottom line by X% and this required a 24% increase in revenue. So that became the starting point! What I found most interesting was no consideration was given to the current market, competition, elasticity of demand, or business process. This is what the parent company demanded, and this is what our bonuses will be derived from, therefore it was the starting point. Way to go! Now when the organization fails to meet the targets it will be a blood-bath in the ranks.

This type of thinking, based on my exposure, is so pervasive in the market place. My exposure to grant funded organizations has demonstrated a slightly different twist to this type of behavior. These organizations put together a budget of what they think they can do, then they put together a plan of how they are going to spend the money. The grant is written to get the money, and once awarded the agency’s mandate is to spend the money. The humor sets in during the tail end of the award period, when there is a scramble to avoid the ominous ‘use it or lose it’ deadline.

Budgets, I have found, take too long, are built on a plethora of assumptions, are mired in useless detail and have a best before date; which is the date it is printed. According to Jeffrey Pfeiffer (What Were They Thinking, 2007), “The average organization spends anywhere from three to six months creating the annual agency level budget. Then this huge expenditure of time and effort seldom produces anything of much value to anyone.” Dave Axson (Management Mythbusters, 2010), “The only guarantee with respect to budgeting is that the more detailed the budget is, the more wrong it will be.”

When I teach on budgeting, my emphasis is on realism not surrealism. The starting point for my protégés is to have a WIG. This is not egotistical self-jactitation. WIG is an acronym for Wildly Incredible Goal. Establishing a goal for what the organization can achieve in the next twelve months and push the limits… make it wildly incredible. From that point, one must work backward to achieving that goal, not based on the mental lockstep of budgeting models, but based on reality.

The plan has to be broken down to achievable goals in reasonable time frames. To this the numbers are added. The great caveat here, which differs from the classical model, is that the numbers attached to activities are based on confidence levels and ranges, and not discrete figures. By way of an example, rent may be set at $240,000 per year with a confidence level of 99% (because of the lease). Conversely the annual figure for transportation may be set at $50,000 with a confidence level of 50%; because we know for sure that the price of fuel will only increase – but what we don’t know is by how much. The reality of this example, vividly reminds me of a northeastern recycling company who, in 2007, built a budget when oil was $60 a barrel. When the price of oil shot up to $140 a barrel, the budget was useless and management was completely lost at what to do.

The reality is that every organization feels the life of the economy. Therefore, our planning must also be able to breathe that reality. Another great fault of the budgeting process is it makes one oblivious to economic opportunity. I recall a dialogue with a senior executive who was faced with an opportunity that had a stellar ROI, but was unable to act because ‘the budget was already approved and this opportunity was not known at that time’. What was wrong with this picture? Jack Welch (Winning, 2005) makes it undeniably clear in “…the budgeting process at most companies has to be the most ineffective process in management.” Mr. Welch brings reality home with “The budgeting process as it currently stands at most companies does exactly what you’d never want.” “It hinders growth opportunities.” “It promotes bad behavior-especially when market conditions change mid-stream and people still try to ‘make the number.’”

Yet, with all the knowledge of the ages we continue down the road of historical behaviors, either because we are so disconnected with reality that we don’t see the futility of our efforts or we simply don’t have sufficient internal confidence and knowledge to break this cycle of futility. Uncertainty has become the cornerstone of the economy, society, and politics and has become so great so as to render the budgeting most organizations still practice-counterproductive if not completely useless. Gladly, as for me, BUDget don’t know JACK!

No comments: