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Is your budget a road trip or road kill?

January 8, 2014

Business planning (aka budgeting or forecasting) can be compared to a road trip.  For a road trip, you identify a destination (sales target for example), the correct fuel and sources to re-fuel (materials and labor resources available), maps and directions (planning, reviewing results, and re-planning), and road and weather conditions (external factors such as materials shortages). You may need to break up the drive, so restroom locations, accommodations and food sources also need to be identified (internal limiting factors).   Unfortunately, a typical business planning cycle often proceeds as follows:

1)      Create a budget for the coming year based on the previous year’s results

2)      As the budgeted year progresses, shift to a forecast with actual results and updated forecasts, using the budget as the basis for the forecasts

3)      Compare actual results to both the budget and forecast figures, analyze the variances (hopefully – it’s scary how infrequently this occurs!)

4)      Repeat for the new year

Too often, the last month of the year is used as the base for the new budget, with some growth factor(s) applied – and that’s it.  However, the devil, as they say so often, is in the details.  It all comes down to assumptions.  What is the growth factor applied based on?  Does it apply equally to revenue and cost of goods?  What about general and administrative expenses?  The reality is that these three areas are seldom in lock-step, and they often have very different drivers.  And they can differ from industry to industry, and even between companies within the same industry!  And that leads to the key point:

What are the key drivers for your business? 

Or in other words, what factors impact results the most?  Which of those factors are within your control, and which factors are you subject to?  Have you built these drivers into your budget and forecast?  Are you missing any key drivers? 

Let’s look at a company that modifies commercial trucks into petroleum tanker trucks.  Assume they have an order backlog for trucks to be delivered as soon as possible.  They can obtain the truck chasses, and can add additional staff to manage the associated production.  So wouldn’t it be reasonable to plan the coming year on that basis, with some additional new order projections layered in?  If these were the only factors, of course.  There are just two minor details… first, the customizations require certain metals.  If cost were the only factor, increases could be passed along to the customers, and it could be managed.  However, what if there’s a production shortage, and they can only obtain so much metal in the coming year and not however much they could use?  And second, speaking of production shortages, as it turns out, there’s a shortage of commercial vehicle tires – and a truck with no tires doesn’t get too far!  So for this company, their budget is going to have limiting factors based on the available metal and tires – that’s the maximum output they can achieve this year unless they can manage to find workarounds for these two issues.  But having identified these issues, they can realistically project the coming year, and they know where they need to focus in order to drive change.  But without identifying the key factors, they’ll be driving blind (can you say road kill?).[i]

 

[i] BTW, these are real market shortages that occurred (and continue).  2004 – 2005 saw a shortage in commercial tire availability, which continues through today.  https://www.google.com/search?q=commercial+tire+shortage+2005&rlz=1C1YBKB_enUS507US569&oq=commercial+tir&aqs=chrome.0.69i59j69i57j0l4.3674j0j8&sourceid=chrome&espv=210&es_sm=93&ie=UTF-8

And that same period saw a shortage in the availability of chrome, which is used in the production of stainless steel and chrome.  https://www.google.com/search?q=chrome+shortage+2005&rlz=1C1YBKB_enUS507US569&oq=chrome+shortage+2005&aqs=chrome..69i57.8367j0j8&sourceid=chrome&espv=210&es_sm=93&ie=UTF-8

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One Comment leave one →
  1. May 20, 2014 7:45 pm

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