The Five Contradictions in Budgeting

Here, in Australia, many businesses are reviewing progress after their first month of the new financial year. Most business leaders are finding the unpleasant truth that the budget, so exhaustingly put together just weeks before, isn’t helping very much.

At the same time many people are questioning whether the rise of the mega ERP systems have helped any part of the organisation apart from the finance function. And everyone is familiar with cascading spreadsheets which allow a myriad of numbers to be produced. All of these are guesses; and usually wrong.

Are we letting ourselves down with the way we budget?

I don't think there's any process in organisations that wastes such a large amount of effort and time for little use as the budgeting process. Almost every business of any size has a budgeting process, but most don't really know why they do it. It's a bit like the monkey on the rope story. “It's always been done that way so we’d better carry on otherwise something terrible will happen.”

It's all about Clarity of Purpose 

There are at least three separate purposes that businesses could have for a budget. These include controlling costs, delivering on a plan and raising performance. By thinking they can do all three, they're more likely to do none of these particularly well.

This is not to say the processes and tools don't have value. They do. But businesses aren't using them correctly. Jack and Suzi Welch recently discussed this in the context of Sales incentives leading to overly conservative targets with no real ownership or trust.

 

Who really owns your budget?

Even the seemingly simple question of who owns the budget doesn't have a clear answer. I know plenty of CEO's who don't feel ownership, despite the fact that they are accountable for the delivery of the financial performance of the organisation. In large corporates most divisional heads would point to the CFO and the finance function. Certainly the timetable of setting a budget may be, but more often than not its for the benefit of the finance function, not the business. These timetables have no bearing on the decision making requirements of the business.

But how about the other stakeholders who influence and are affected by a business's financial performance? What do they need?

For medium-sized businesses, a bank may be a key stakeholder, as this provides some comfort especially in the Australian tick-boxing banking culture. Businesses that are subsidiaries of larger companies focus on profit and loss statements to keep the central financial team happy. It's "comfort", not decisions, these guys are after.

When we look at deploying the plan into the rest of the business, often the primary tool is the budget. How much effort goes into not only item by item budgeting but also tracking these items each month? A fellow TEC Chair, Barry Upfold, is always reminding members that the one budget line all companies are good at meeting is the expenses line, notwithstanding what the revenue line is doing.

Beware the Five Contradictions!

1. Precision over timeliness

How often have we had to wait for the results because the numbers aren't in? The precision required should be defined by the owner, not by the accountant. In 2016 there is no excuse not to know within hours of the end of a period how the business is tracking. The purpose is to inform and to frame the conversation, which then leads to decisions. 

2. Reconciliation over performance

Double-Entry book-keeping was never designed to help run a business. It is brilliant as a control of mis-allocation and fraud and is embedded in the training of professional accountants. But it doesn't inform performance. It doesn't inform progress. Broad brush variance reports can ignore small item reconciliation without losing sense. The purpose is to inform and to frame the conversation, which then leads to decisions. 

3. Review over foresight

Many people use a budget as a control. But a control against what? A frantic ”Finger in the air” guessing game conducted in the six weeks prior to the new Financial Year? It's a actually a poor tool for controlling actions and spending. This is mainly because it is used for review; Lag indicators of course can show trends, but other sources of information are better indicators of the future.The purpose is to inform and to frame the conversation, which then leads to decisions. 

4. Compliance over strategy

Here in Australia we have plenty of compliance obligations. We like our rules. Tax compliance, employment regulations, company obligations specific to industries all need to be monitored. Some of these need regular updates but most just need a periodic overview. The risk is a focus on this compliance rather than on responding to external factors that change often on a weekly, monthly or quarterly basis.   The purpose is to inform and to frame the conversation, which then leads to decisions.

5. Adherence over Response

Often the budget is the main tool keeping alignment to a plan or strategy. Just as most five year strategy plans can be criticised as being too rigid, even an annual plan is become less fit for purpose in many industries. In VUCA world, the merits of an annual plan are questionable and can be downright dangerous. An inbuilt agility is increasingly essential for survival.The purpose is to inform and to frame the conversation, which then leads to decisions.

The purpose is to inform and to frame the conversation, which then leads to decisions. 

Businesses need to narrow down the purpose of their budgets, aiming for clarity rather than a scattergun approach. These processes are often wasteful enough without bloating it further by trying to achieve too many objectives.

We still need financial controls. We still need compliance and audits. We just need to separate these from trying to drive performance of the business.

A focus on Accountability 

Accountability should not be just about sticking to a plan but maximising performance. This informs the conversation and the decisions arising. So we are designing a conversation and decision making framework, not a set of reports.

 

Key Elements in design

1. Create an ongoing process rather than a once off.

Too many organisations start their new financial year at zero. Why? was there some miraculous transformation in the market at the end of the last financial year? Nick Setchell, one of TEC and Vistage's best speakers encourages businesses to look at trailing 12 month results. This overcomes seasonal cycles, smooths out 4 and 5 week months and generally brings the focus on more strategic issues and underlying trends. Once that is mastered look forward and do a rolling 12 month forecast ahead; Once mastered it is no extra effort and a lot less disruptive than the usual budgeting hiatus. If this seems too hard, then start off on a quarterly basis and reset the priorities each quarter.

2. Performance measures focused more on lead indicators.

What drives revenues? How do you monitor these? What drives a gross margin? Utilisation? Delivery in full? These operational measures are the levers that drive the financial performance. Drive looking forward, not using the rear view mirror. Some decisions may lead to more project oriented improvements; use milestone a progress monitoring as part of the same discussion.

3. Make the invisible, Visible

Many CEO's I know have mastered the art of looking through detailed financials. They carry that ability with pride after having spent several years effort. What they forget is that it isn't just them who needs to understand the key numbers, its everyone else. Use graphs, trendlines, trailing averages, pictures. Visual management is the key to an engaged conversation, where every one not only receives the same information but shares it in real time. Less politics, more transparency, quicker action.

Just as many operations have workplace boards, start with a visual management board at the top of the organisation. 

4. Remember, Cash is King

For most businesses, financial reporting focuses firstly on the Profit and Loss statement, less on the balance sheet, considered by some business owners as something to focus on at year end. But for most businesses the working capital movements are critical; in fact in the short term can make the difference between whether a business survives or not. The saying "Revenues are vanity, Profit is sanity and Cash is reality" has been borne out over the centuries. Cash flow forecasting is often a lot tougher than forecasting profit. Many organisations choose not to cascade cashflow drivers down into the organisation; they get what they deserve.

I'd be interested to hear of others' experiences and journeys and if you have other suggestions to the basic elements I've outlined here.

How the focus on year end destroys value

Here in Australia the tax year ends 30 June. The retailers are into a frenzy of EOFY sales and every road that can be repaired is being dug up to use up unallocated funds.

The Japanese have a word for it. Mura - unevenness. This unevenness is costing the economy billions. Because unevenness causes all sorts of other waste - over production, errors, excess inventories. The list goes on. This is even more extreme than the "end of the month" syndrome.

Much of this is of our own making. June 30th is just the end of the tax year. That's all. Except for tax treatment it is a completely artificial deadline. 

Deloitte recently released their latest paper on red tape focused on companies' own rules entitled "Get out of your own way" and I'd certainly include the budgeting and financial reporting that businesses do as part of this. 

Once the financial year end is out of the way and your CFO or Financial controller has come back from their nervous breakdown, do yourself a favour and review your whole process to get rid of the waste and frustrations of a process not designed for purpose.

I'd review the process not just on the "budgeting" or "reporting" bits but on the whole Joined Up process of strategic management. Very few businesses can afford to wait for three years for a new strategy and need to review this more frequently, quite possibly more frequently than annually. And if that's even partly true, then the annual budget doesn't fit any more or at the very least isn't enough.

In reviewing the process some obvious questions to ask are:

1. Timing. When would it be most logical to have the company financial year and how closely should it be linked to the planning cycle?
2. Frequency. Why only plan and forecast annually?
3. Purpose. What is the purpose of the budgeting process? For whom? if its for the accounts department - you've got a problem.
4. Accountability. How do you intend to get real accountability? Hint: most budgets don't do this.
5. Decisions. What real-time information do you need to run the business?
6. Clarity How to communicate progress against real (not artificial) goals

Some solutions businesses are now applying include:

1. Have trailing results and a rolling forecast. Don't have a massive budgeting process but review performance every month INCUDING a forward 12 month view. The power of a trailing 12 months is that seasonality is always allowed for and a forward looking 12 months then only one month is being introduced - all the others are just being reviewed for any obvious changes. For more on this TEC speaker Nick Setchell has some fantastic tools
2. Look at cash movements. The Profit and Loss statement  will need  modification if you are really going to run your business effectively. Alan Miltz, another great TEC speaker, reminds us that in particular working capital movements are essential to monitor and plan and operational strategies can have a big impact on the cash generating abilities of the business  
3. Use Visual Management -  Graphs and Trends. The CEO may have got used to a spreadsheet full of numbers, but it doesn't mean the executive team have. If you don't show it graphically, with the distortions taken out, your team won't see the same picture as you. If currently graphs show a sawtooth pictures of sales and profits, smooth it out by using a rolling 3 month or accruing some expenses.
4. Focus Accountability for tactical activities on the shorter term. Consider quarterly targets; usually 12 months is just too far away. If you wish to share some form of self funded bonus then this also can be done more effectively on a quarterly basis with the carrot dangled a little close to the nose of the sales teams - and less temptation to ease up.
5. Avoid driving by the rear view mirror.  Financial results are an outcome. The business is driven from inputs - so ensure as a management team these make up the bulk of the indicators you drive in the business.

It's Not Personal - It's Just (Family) Business

Consistently voted as one of the greatest movies of all time, The Godfather is a goldmine of business and leadership lessons. The movie highlights many of the biggest issues facing any family business, in particular the tension between “business” and “family” and even more acutely between the founder and the next generations.

Anyone running a family business knows what I’m talking about. It's never easy to transition even with the most benign family environments. Add a mix of sibling rivalry, a divorce or two and the scenes in Godfather are all too recognisable, actually they are mild compared to real life. It's the second and third generation of business ownership where things get particularly challenging, as this means there are more and more voices trying to make decisions - often with gut instinct rather than strategic rationale.

I work with several family business CEOs and last month I was lucky enough to hear the CEO of one of Australia’s most successful family business describe his story. What struck me was success was linked to a clear governance structure. Sustainability is all about transition from the founder to a more structured approach, which includes a need to be hard headed about the legacy business as the world gets smaller and more competitive.

The challenge, then, is to create a system of governance that preserves the various strengths associated with a family business while limiting many of their inherent weaknesses. To do that, we need to look at the path many family businesses take as they grow.

There isn't always a clear exit strategy

While true entrepreneurs from day one know that they're growing a business to sell it, not every business is formed with a clear exit strategy in sight. There is a minority of founders who set up a business with the sole purpose of passing it across the generations, most only work this through once the business is truly established.

There are plenty of examples of family businesses that have become bigger and bigger over the generations. The confectionary empire of Frank Mars is now into its second century, still 100% owned by the family. Cadbury went 150 years before it started to lose the family ties. Ford is still recognisable as the company Henry founded and the family is still involved, but at shareholder level. These are just the tip of the iceberg. In Australia where I now live there are many privately held but exceptionally strong family businesses that haven’t hit the headlines. But the issue of influence, of ownership and power is as acute here as anywhere.

It's this distinction between ownership and governance that's so important for family business owners to be aware of, as it allows them to find more effective ways of balancing power between multiple stakeholders. Peter Crow, who specialises in Family Business Governance, said that a family business needs to use a proper board structure when the owners can’t all fit round the kitchen table. I think that is a really useful image.

"A family business needs to use a proper board structure when the owners can’t all fit round the kitchen table" 

When does a business need a Board?

Once the ownership gets that size, then by definition not all can have an equal voice. Without proper governance, Uncle Ned will feel he has been undermined, Auntie Florence still wants to invest in her pet project, Cousin Jack wants some money to invest in his own business. And Dad, who is now 85, still sits at the head of the table and thinks that what got the business to where it is today will keep it there.

Strong Governance is now essential; emotions are likely to get more intense otherwise. In many ways the issues are exactly the same as those faced by Publicly Listed Companies – investors need to be informed, but be kept out of micro management and they need to entrust their wealth to others, who manage the business in the interests of all stakeholders.

What Governance is, and what it isn’t.

Governance acts as a necessary antidote to the emotions and gut-feelings that so often dictate decisions in a family-business environment. Adrian Cadbury's definition puts this into perspective, defining governance as "The system by which companies are directed and controlled".

"System" is the key word in that definition, as the very mention of the word separates it completely from anything that could be inspired by gut instinct or emotion. Instead there are processes in place that channel the potentially disparate whims of family shareholders into actionable decisions through the professional CEO supported by some independent minded Directors.

There's a common misconception that governance is compliance. Peter Crow emphasises forward looking business strategy as the priority; compliance is purely a rear view mirror exercise. With most businesses expected to be disrupted significantly within the next 5 years it is almost criminal not to have both strong governance and a forward looking strategic stance. This in my view should be led by the CEO but with an Independent Chair managing the Governance process, supporting the CEO and managing the interface between the business and the family.

Who has the Courage to make the change?

Family businesses often have a unique set of inherent values which have significant effects on the way the business grows and how the topic of succession is discussed. They can be patient and benefit from the virtues of patience in that they tend to have stronger balance sheets and are less dependent on debt. This also means they can take quite exceptional risks in new ventures.

However, there is always a risk that later generation family members develop a sense of entitlement, an attitude of inherited wealth and an expectation of a job to fit their lifestyle.

At some point a second generation leader has to step forward and implement the transition as a professional CEO.

The courage this requires is exceptional. The founder may acknowledge the need for succession, but rarely without some misgivings. The extended family anticipate, correctly, the loss of their direct control. The leadership role here is a massive communication effort to the extended family to promote the inevitability of the transition and the underlying principles of fairness, accountability and creating value.

Key Elements for a Sustainable Family Business

Governance Structure

Separate the extended family from running the business by having a Council – with broad representation from the current generation and a Board, with both family and independent representation and an independent chair.

Leadership and Succession

Choose the best people to run the business whether family or not. Family members who wish to pursue a career in the business get help in training and development to give them the best chance, but no automatic entitlement.No family member should expect a job as a birthright or entering the business in a management role.

Values

Enshrine the original founder’s values with the purpose of sustainability, but do not get stuck in heritage. These include the respect for the Board’s authority in running the business and the Council’s authority in dealing with family distribution issues etc.

Strategy

Focus on creating family wealth and sustainability. A rational and value driven approach to business opportunity with a long term investor mentality; many times this requires some portfolio thinking and diversification from the core business and sometimes this means the original businesses are eventually passed to others.

Those CEOs who have succeeded in this transition usually recognised early on that they cannot do this alone. Advice from outside the family and strong emotional support from peers and mentors is at the heart. Expect the journey to be rocky at stages and keep an eye on the longer term prize. In Australia support is available from TEC groups and from Family Business Australia

I'd be interested to hear of others' experiences and journeys and if you have other suggestions to the basic elements I've outlined here.

Image Credit: An original illustration by Hamish Lindsay. 

A Joined Up Journey to Business Excellence

When senior executives and business leaders are trying to get their minds around how to raise the bar in business performance where do they look?  The latest Guru Superhero's book? Inspiring articles or TED videos? The trouble is the focus is more usually on the achievement and less about the journey itself. For most people trying to transform their organisation its messy, its hard work and the day to day urgent things get in the way. "Surviving" is the usual word, not "Thriving".

Share with others trying to achieve sustainable excellence

One of the best ways is to acknowledge that you are on a journey. Sharing the experiences and the real challenges with others while studying inspiring examples is a way to envision what excellence will look like for your organisation. At the same time, it is allowing you to acknowledge you are in pursuit of perfection, but you sure as hell haven't achieved it yet!

One model that aims to help organisations achieve excellence is the Shingo Model™. The Shingo Model is not an additional program or another initiative to implement; rather, it introduces Shingo Guiding Principles on which to anchor current initiatives and to fill the gaps in efforts towards ideal results and enterprise excellence. The flip side of this is if you don't apply these Principles you are in danger of losing momentum or start going backwards. "

The ten Principles are shared below

Its all about behaviours

As Peter Drucker once was supposed to have said "Culture eats Strategy for Breakfast". By "culture" what we are really referring to is the way we behave in and organisation. The Shingo Institute also has identified Three Insights of Enterprise Excellence™ around behaviours. 

1. Ideal Results Require Ideal Behaviors
2. Beliefs and Systems Drive Behaviors
3. Principles Inform Ideal Behaviors

Way too often business performance improvement is focused on Tools, Structure and Processes only. Many training courses are academic exercises leading to tick box qualifications. A focus on behaviours requires reflection, sharing and, for a leader, an honest assessment of their own behaviours.

A structured approach to Managing by Walking Around

What leaders need is a structured approach to identifying behaviours against a set of principles. For most this is uncomfortable, new and hard to put into practice. It isn't a "Regal Tour" talking about the football but a purposeful conversation aimed at uncovering ongoing issues and opportunities. In short it needs practice and a willingness to go though an unfamiliar and potentially uncomfortable learning process.

Don't try this on your own

Just like any habit forming find some peers with whom to share the experience. Manufacturers usually can find some kindred spirits but for service businesses this is still in its infancy.

The Shingo Institute, through their affiliates (SA Partners in Australia) run experiential workshops hosted by a local organisation already embarked on their journey. Details are linked below.

Hey Jonny, here's a Dopey Idea

What are the elements in a truly Joined-up Strategy?

"Hey Jonny, here's a Dopey Idea"

Jonathan Ive was almost unheard of until a few years ago. Some of you may still be asking "who is Jonathan Ive?" Well, every day 200 million of us use the products he designed. On 19th October 2011 he shared the stage with others in one of the most inspiring events of Corporate leadership ever, the day that Apple employees said goodbye to Steve Jobs.

What Jonny shared that day is insight into the remarkable relationship between himself and Steve. But what he was really sharing was the process of creation. His core message was the frailty of a freshly formed idea, so easily "squished" to use Ive's native English vocabulary. He emphasized that to create something (in the case of Apple, several insanely great products) you need Dopey Ideas, sometimes truly terrible ideas as well. That to deliver something new requires not only great insight, but also the perseverance to focus on the little things.

His highest praise for Steve Jobs was for “Givin’ a Damn" because, in the end, even things that are hidden from the human eye do make a difference.

Most businesses don’t have the scale or vision of a Steve Jobs or a Jonny Ive. But Apple's brilliance is less about amazing technology but more an entire business design. They focus on the 100% solution. They changed the music industry; they designed distribution channels, supply chain organization and brand marketing.

In the process Apple achieved a remarkable triple.

1.     It has become one of the strongest Global brands in the world

2.     It employs some of the best and most passionate technical and business people in the world who clearly do care

3.     And it just happens to have more cash in the bank now than the entire United States Government.

These three facets are not just coincidence. They are a result of the ultimate “Joined Up Strategy”. And it didn’t start by saying “Hey, lets make $80 Billion”

Just as Ive describes the creative process at the top of Apple, we can see that it also applied to the Apple strategy process too.

It will have required plenty of dopey ideas and several terrible ones as well. But it would have allowed the ideas time to build into something worth persevering with. This wasn’t Steve Jobs, this was a team. It was a team, working on a 100% solution. And the Strategy was Joined-Up.

Have you got a Joined-up strategy?

By joined-up, it means recognizing that you will achieve financial results as a result of building other parts first. If you have a great product or service, remember that you also need to clearly and explicitly describe your values, because together this creates your customers perception of you, your “Brand”. Your values also, together with your business model (how you deliver your great product or service) directly effects how your people behave. And if you have the right customer proposition and the right business model - then and only then will you achieve the best possible financial result.

This is true for the smallest business right up to the Global giants.

A great Joined-Up Strategy is created in the same way an iPhone or an iPad is created. It starts with ideas, precious, frail ideas – all too easily squished. There is compromise, but not to the ultimate goal. There is perseverance and ultimately focus on the finer details. And there is care, passion, belief, elegance, excitement and ultimately “Givin’ a Damn”.

A Joined-Up Strategy starts with leadership and an alignment of the top team to achieve an ambitious or challenging goal.

Is your top team aligned? Do they really share an ambitious and challenging goal? Do they truly give a Damn? Or are they just focused on their own little silo?