Budgeting in Troubled Companies

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In a public company environment, management takes budgeting and monthly variance reviews for granted.  Senior management reports its earnings outlook to the analyst community and then manage activities to meet those earnings expectations.  These disciplines are often lacking in private mid-size companies and are even more often lacking in troubled companies.  In fact, that is often one reason a company is troubled.  Budgeting and variance reporting are all intended to force management accountability and results.  Without those disciplines you get “drift”.

In addition to being used to manage toward profit goals, budgeting and the subsequent variance reports are useful in strengthening a company’s system of internal accounting controls.  Often during variance review meetings accounting errors pop up as variances when comparing actual results to budgeted expectations.

When we refer to a company’s budget we are referring to a frozen annual budget that is established before the start of a fiscal year.  Typically, management prepares this in the last quarter of the prior fiscal year and presents it to the Board before the start of the new year for approval.  All management authority rests with a Board and in approving a budget the Board is delegating to management the “general” authority to run the business within the context of the approved budget.  (This assumes the Board has already approved the Strategic Plan for the upcoming year.)  Without approval of the annual budget management essentially has no delegated general authorities.  The budget also sets the Board’s year-end profit expectations for the management team.

Management must view the budget as a sort of contract with the Board.  Management can’t exceed spending limits beyond certain pre-approved thresholds without getting specific approval from the Board.  And the Board has every right to expect the profit goals to be met.  That is why the budget is a “frozen” annual budget.  If it kept getting revised, it would be like a moving target that management could manipulate every time the profit targets prove to be challenging.

How should profit targets be set?  That would depend on a variety of trends, including the state of the economy, the Company’s product or service growth curve, changes in legal regulations impacting the company, etc.  I like to see realistic budgets for accurate planning purposes, tempered with some challenge to management to grow the company.  The term I like to use is “reasonably attainable stretch goals”.  The frozen annual budget should be set with reasonably attainable stretch goals.

Budgeting should start in the fourth quarter of a fiscal year.  During that period there should be a halt on management’s taking on any new major financial commitments that would impact the upcoming year – unless of course the Board approves – prior to completing the year’s financial plans.

The Accounting staff should distribute budgeting templates for cost and profit center managers to use in preparing the upcoming year’s budgets.  Those templates should include historical sales, cost and expense trend information.  The budget line items should line up exactly with the line items in the company’s P&L or Variance reports for ease of monthly reporting.  A budgeting schedule with submission deadlines should also be distributed and enforced by the senior management team that allows their review and revisions and submission to the Board for its approval before the start of the upcoming fiscal year.  It would be unusual if a budget didn’t go through two or three iterations before it is finalized.

Once the budget is approved it should be uploaded to the Accounting system so that variance reporting can be automated.  Variance review meetings should be held monthly as that allows management a maximum number of points to review progress against the profit plan and to take corrective actions to get things back on track, if necessary, to meet the Boards year-end profit expectations.

Frozen annual budgets and monthly variance review disciplines are essential tools in helping to turnaround troubled companies.  If your troubled company doesn’t utilize these tools, it is unlikely it has a chance of being turned around.

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