Weekly Reflections - Budget
EXPRESS_17600 | Budgeting_Video
The following presentation is about preparing your financial commitments, essentially a guide to developing a
budget as the leader of HISCO. The pitch can also be found in the Help section of the Supplementary Review
Materials. What time of the year do the majority of managers dread? Budget time. We're going to try to make
some common sense of preparing a budget for you as the leaders of the HISCO organization.
What is a budget and why is it critical? Like strategy, there are a wide range of definitions of a budget. From our
experience, a budget is a systematic process of the allocation of corporate resources with a typical duration of one
year. Over time, often 3 to 5 years, the annual budgeting process is designed to achieve your strategy.
There's an ongoing process of cross-functional partnering, to properly balance, and succeed across your value
chain from supplier to end customer. This inner linkage becomes the basis of your financial commitments for the
upcoming year. The financial budget will link your pro-forma income statement, balance sheet, and statement of
cash flows, involving operations, investment, and financial components.
Naturally, budgets will involve a balance of non-financial measures. Budgets need inherent flexibility and control.
There are many types of budgeting processes you would want to learn about from rigid to zero based. And the
debate is nonstop on topics such as sandbagging, stretch targets, and reward systems tied to meeting or
exceeding budgetary measures.
Why is the budgeting process critical? Well, it's criticality stems from the fiduciary responsibility to all of your
stakeholders with the ultimate goal of creating shareholder value. We can measure our progress with variance
analysis and course correct when market conditions warrant. As an individual, regardless of level, a budget
drilldown will allow you to find yourself and your potential contribution to overall systems profitability.
It's a forcing function to understand the drivers of your business and constraints you will face and creates
alignment across your organization. It makes everyone a risk manager. And the risk of running without a budget is
the equivalent of allowing people to run wild.
Planning, budgeting, and forecasting are three interrelated and often misused terms you will experience in
managing and leading HISCO. In practice, these terms are frequently used interchangeably. All require optionality
and a risk management perspective.
Planning is at the strategic level with a long-term perspective involving senior business leaders. Budgeting, the
current activity that you will be experiencing at HISCO, is at the operating level, typically with a one-year duration
involving an entire organization primarily around your financial commitments.
Forecasting is also at the operating level that recasts or updates your budget, typically occurring monthly or
quarterly or whenever market conditions warrant. This revised forecast is often referred to as your short range
outlook.
Your owner's net income expectation for the year was well documented in one of the early internal e-mails. You'll
recall that Stanley Sloane was not happy with the prior management's commitment of roughly $230,000. And he's
expecting a net income commitment from you of between $300,000 to $400,000. You can find the original prior
management's commitment in the Financial Metrics section of the Current Decisions that we'll talk a little deeper
about as we go through this presentation.
Subsequent to this video, you'll be seeing suggestions for Q1 and you're preparing your budget commitment.
Please read these very, very carefully. You can close at the bottom. You can always reopen in Current Decisions
under the guidelines.
As part of planning, you will recall that we have already asked you to be thinking about your strategy and SWOT
analysis. This is absolutely critical because this will be driving all of your operating decisions within your budget
and it is essential that these decisions always be aligned to what your strategic direction in HISCO is going to be.
To begin preparing your budget, you would go to the Current Decisions area of Quarterly Decisions. Please note
that budget and plan are used synonymously within. The first aspect is they'll see where the drivers of your plan
actually are, the decisions. You will also see the actuals for the fourth quarter of the prior year.
Your input area, the four quarters of the year you will be playing, has the data that reflected the rollup of the prior
management, which you know your owner is not satisfied with. We will now be going into a little deeper each of
these areas.
A useful area to always review are the internal e-mails. You had last seen these when you were preparing for the
self-test.
As part of the budgeting process, always go back when necessary and look how your various decision categories
impact results. There are numerous lag relationships just as there are in the real world.
As you look at the top half of Current Decisions, you will see a variety of graphics, which will become increasingly
important as you proceed through the year. The most important right now is the market forecast. And you can see
in the upper left a 90% confidence interval around the mean value.
The values that the prior management had in place were roughly approximate to the mean value. And of course,
these can change. And as you apply your share assumptions, you should be getting your units sold. These are
critical drivers for everything that follows within the budget.
The bottom half of Current Decisions is where all of your inputs will actually be made within the four columns.
Again, the current numbers reflect the prior management's decisions. And any of these can be changed.
As you change inputs, always model your plan to find out what the impact is within your budget. Understand that
there is that one quarter lag under normal conditions. For example, on raw material orders, as well as lines
coming in with a lag of one quarter.
It is critical in preparing your budget to understand the linkage of your financials from the past to the future or pro-
forma. Within Financial Statements you will find the tab called Financial Metrics. This is one of many tabs within
Financial Statements, but a critical one. And you will find the historical run rates in various financial metrics, which
you should study, as well as the projected ratios based on your current budgetary inputs.
There are some important aspects here. Always be watching the trends in the data. Too much volatility can be
very self-defeating in any process.
And always avoid the slippery slope. And what that means is once you get on a down trend it can be very hard to
get off it. It could take a few quarters to start recovering.
Balancing your supply chain is critical in the budgeting process, both from a historical and pro-forma perspective.
Within the Supply Chain Management tab, you will find the production segment where all of the constraints from a
historical basis and the run rates to the pro-forma basis based on your current budgetary projections can be
found. This should be examined very, very carefully. Watch the trends, balance to your market forecast and your
share assumptions, and leave some buffers for the unknowns. For example, a little extra inventory is OK because
if you have lost sales where you cannot meet customer demand what you're trading off is the extra cost of
carrying that inventory for the really unknown opportunity cost of the lost sales and what it means for the
customer.
R&D is critical in the budgeting process to balance the short and long term and certainly to leave our business as
a going concern. The prior management had started investing in Project 2, and we certainly hope that you will
continue that funding in quarter one. There are two other projects, Projects 1 and 3, which you can read about.
And in particular, on Project 3 this is the expanded market opportunity. And the key here is to ensure that you
have capacity planning in place at the time that you actually implement project number 3. We suggest you go back
and read in the inbox in the internal e-mail the impact on the total demand from the implementation of Project 3.
Role play is one of the unique opportunities within your budget preparation to gain competitive advantage. It is
absolutely essential that you read the directions and guidelines very carefully. Any unused calls will have a large
opportunity cost. In the first quarter, quarter one, you will have three calls. And they can absolutely positively
impact your budget commitment and the probability of meeting and / or exceeding it.
As you are creating your budget and continually modeling your plan you will find that a variety of constraints will
pop up. In this section, for example, you can see that based on your inputs for Q2 there is a variety of production
problems, as well as a cash problem. These issues also occur in the other quarters also have to be addressed.
It's also very important to recognize that you cannot submit a plan that exceeds your credit line. So please be alert
to all the budgetary constraints.
In summary, everything drives your budget commitment from your financial metrics, to your production and supply
chain, to your R&D, to your role play, to your inbox, to all of the constraints and numerous other items that you
can find in your Quarterly Dashboard. There is one truth. Even though in practice budgeting involves quantifiable
projections and a working knowledge of integrated financial statements, it is too important to just leave to finance.
It needs to be a very cross-functional activity linked back to your strategy.
As we approach the final countdown to creating your budget there are a few important things to reiterate. Ensure
that your net income commitment is in the range of $300,000 to $400,000 expected by your owner. Always link
back to your strategy, balancing the short and long term, thinking cross-functionally about your value chain from
supplier to customer. Understand the history of HISCO and what it means for the future. Be a minimum of 70% to
80% confident that you can deliver.
Budget in quarter one for the Market Report and Business Intelligence Dashboard to remain knowledgeable about
your competitors. This can be found at the bottom of your input area. And finally, budget the way you desire to run
the business, not necessarily the way it's accounted for. We wish you luck in creating your budget.
The budgeting video can be found within the Help section of Supplementary Review Materials. Good luck on your
budgets.