Budgets: more than a sum of the parts

Financial Director:

Budgets are still at the core of what the finance function does and is responsible for. But the budget is an internal control mechanism, a business plan, a forecast, an authority to spend and so on. We have a fascinating mix of businesses here, from manufacturing to professional services. It will be interesting to see just how much our problems are the same.

Rob Sewell (NatWest Life): The last company I worked at had what was a classic issue: we had a carefully framed, detailed budget carved out after sitting down with cost centre managers for weeks, crafting detailed cost analysis. Within two or three months, sales performance wasn’t what it should be and one was left thinking, what can we do about costs? The classic assumption is, if it’s in the budget then it’s okay: maybe put some rules so we can’t spend anything on training, second class travel rather than first class – but after that one just hopes sales will recover.

Bruce Kesterton (Thomas Miller): I come from an organisation where the budget is deemed to be remarkably unimportant, populated by people dedicated to servicing the client – which is great – but it’s a real pain trying to run a business that way.

Robert Dix (CCF Charterhouse):It’s exactly the same in our industry – the budget is pretty much ignored by all businesspeople and the only people really interested are the shareholders [the French parent bank] – but only in a few key ratios.

Kathy Jehle (Comshare): At Comshare the situation is much more like Rob [Sewell, NatWest Life] described where your costs are pretty well fixed and very easy to predict. Revenue is very difficult to predict and if revenues aren’t up to budget then you need to sit down and say, ‘Okay, who’s going to put the costs back on the table?’

Richard Hewitt (Corus): Our biggest problem was the gestation period and economic factors. Our year begins in April, so the first round would be in August and it’s only in April that the board reviews the budget. By then, of course, exchange rates and economic growth were way out of date. Nevertheless, that continued to be the basis for all monitoring of the results of the individual businesses throughout the course of the year. You could argue we should be looking at rolling budgets and perhaps we will.

Financial Director: I remember from August to November 1998 we were asking, ‘How bad is this recession going to be?’ And between November and April 1999 we were saying, ‘It looks like we’re going to avoid it!’ By April fears of recession had almost gone.

Hewitt (Corus): You create an economic view of what the DM is going to be for the rest of the year – something like DM2.75 – and by the time you actually do the budget it’s probably up to DM3. It’s now at DM3.20 so the economic factors that impinge on British Steel are huge.

Kesterton (Thomas Miller): In the example that Richard has just given, the biggest risk is the currency. One of the most valuable things that comes out of it is identification of the really big risky areas and whether you can or can’t do any thing about them.

Ray Morley (St Ives): I don’t think you need a budget to identify where your risky areas are. Using a budget to identify where the risks are means you are detached from what’s happening in your business.

Kesterton (Thomas Miller): Using it to identify risks certainly occurs in our business.

Morley (St Ives): I think there is an essential difference between ascertaining what your strategy is and what your budgets are. I think the two are essentially different.

Financial Director: It seems as though some organisations are struggling to get people to pay attention to the budget because they are too busy servicing the client, whereas in manufacturing industries the bulk of people are not client-facing but are being largely affected by external economic factors. Gary, what’s your view on this?

Gary Simon (Deloitte & Touche): I don’t think it’s different just because you are using people rather than machines. We all want to engage more people in the process and would like managers to better understand the drivers in the business – and to tell the finance department what shape the business is in.

David McLaughlin (Linklaters & Alliance): Introducing technology to partners is very useful just in terms of general education: 18 months ago they didn’t even know what the turnover was that they were supposed to be achieving. They also assumed that if you spent some money it was ‘free’. We can also show them what the real drivers of the business are and how by moving one lever they can effect real change. I sense a great maturity now that they feel they can really affect the outcome of the business.

Sewell (NatWest Life): As long as you use the budget for two purposes – control of the business and as a tool for understanding how the business is going to perform – it doesn’t wear its two hats very well. As long as you have that control side, people will always want to use it as a negotiating ploy. You have to find another way of managing your costs, whether you use a staff-to-non-staff ratio, linking income to expense ratios – whatever, you just need something else.

Simon (Deloitte & Touche): As the process becomes easier you can involve more people. Then there will be more time to examine the results. Taking Ray’s point about risks: sometimes you don’t know the probability of those risks happening. If you can get better insight into the data through multi-dimensionality, then you can work out with the rest of your business managers how you are going to reduce those risks.

Morley (St Ives): I think that’s the difference between establishing a budget as a form of measure and having a business model that enables you to tweak various parameters within it to see what the likely impact will be.

Financial Director: A problem I’ve come across is if you’re thinking about an opportunity that’s going to cost a bit of money, you’d better have that idea in September or October and get it into next year’s budget because if it arises in March/April you won’t get it through.

Morley (St Ives): Ironically, I think many projects that are not budgeted tend to be the ones that end up being slightly more successful, because they are opportunistic: people fight to get those things in.

Sewell (NatWest Life): Turning Ray’s comments on their head, projects that are included in budgets are a lot harder to remove – even when it’s felt they won’t actually make sense – because somehow it would reflect badly on the management: ‘Why was it in the budget in the first place?’ In my experience, you get a much easier ride for a duff project that’s in the budget than for a good project that isn’t.

At NatWest Life, a fairly small subsidiary of an even bigger organisation now [Royal Bank of Scotland], our budgeting process involves us pitching in with an initial estimate in April/May, which goes right up to main board level. No one up there understands our business because they are all bankers. They then come down with a target for us which is normally 10-15% more than what we submitted. We work through all the detail in August/September/October, submit the plan, it gets reviewed – ‘No, that’s not enough: add another £5m to £10m.’

Morley (St Ives): So it’s a completely pointless exercise.

Sewell (NatWest Life): But a lot of large organisations work that way. At the board level they say, ‘Our shareholders expect this performance: it’s 20% more than what the sum of the parts seem to be saying we will be doing next year.’

Jehle (Comshare): So why don’t they just start there?

Dix (CCF Charterhouse): The reason they add up all the parts and decide that it’s not enough is because all plcs these days are fighting to not get taken over. They’ve got to somehow keep the graph going upwards.

McLaughlin (Linklaters & Alliance): You can take six months out of the process by giving the unit the answer before it starts. If part of the plan is to have 10% growth every year, then they should know it before.

Morley (St Ives): There’s no point saying from the top down, ‘If your budget’s not going to show 15% profit growth then don’t bother sending it in.’ You might as well regurgitate last year’s budget.

Simon (Deloitte & Touche): What it needs is to come from both directions: senior management have some aspirations about the business and local management says, ‘Well, I can’t meet you all the way but I can do this or that’ – and then there is a meeting of minds. That collaborative spirit is missing from those budget cycles.

Morley (St Ives): We do budgets and quarterly forecasts, but the guys at the top are very close to what’s happening – it’s not multi-layered, so consequently MDs of operating units have a voice. You need to have in your business a degree of honesty within the budget. If managers can’t feel they can honestly present their concerns and hopes for the budget then it’s just a big exercise in kidology. If everyone’s going to hold stuff back – ‘Silly sods in head office don’t realise what’s going to happen’ – then who’s won? It certainly isn’t the business.

Sewell (NatWest Life): RBS is taking over NatWest, a company two or three times its size. The reason they were able to do it was that NatWest disappointed.

Financial Director: We’ve talked about pointless exercises and the difficulties of getting projects through. We’re pointing the finger a little bit at the board of directors or at business unit managers who are trying to spend their training budget. I can’t help feeling that maybe there are failings within the finance function for not being as integral a part of the management of the business as perhaps we like to think that we are. Is that a fair comment?

All: [stunned silence]

Financial Director: Is there an understanding gap?

Kesterton (Thomas Miller): Certainly not!

Dix (CCF Charterhouse): There isn’t any understanding gap. When I say I can’t get people interested in the budget, it’s because they don’t run their business on a budget basis. They understand their budgets in terms of how to put them together, but it’s just not particularly relevant to them in terms of how they manage their business for maximum profitability.

Financial Director: Are they right to regard the budget with such disdain?

Dix (CCF Charterhouse): I would like to see them use the budget a little bit more in terms of cost control. Although their profits are driven from their own profit centres – it’s ‘Well, I’m making a profit so I’ll decide how I’ll spend my costs’ – they don’t want anyone else to dictate to them.

McLaughlin (Linklaters & Alliance): We’ve made a quantum leap in the past two years in reinforcing the fact that the people are responsible for the numbers: we have now got that merging of finance and business. Two years ago, finance was seen as something disconnected from the business.

But I think also everyone is far too introverted in looking at the budget and not looking at what’s happening outside in the market: if 10% better than budget is good, but all your competitors are doing 50% better, then you are not doing at all well. The focus should be on the market and how much of that we are getting.

Simon (Deloitte & Touche): With regard to the issue of share prices, if you declare to the market how performance really is, then quite often the analysts will understand it. What they can’t stand is when you don’t know what the hell is going on in your business and you take them by surprise.

It’s vital that the budgeting system can cope with the different drivers and different business units. It’s also vital that the person at the top can understand the different business drivers and what is happening in each of those businesses so they can explain it to the market. It’s really a question of managing expectations through better information.

Financial Director: Gary Simon, David McLaughlin and Bruce Kesterton aren’t terribly concerned with share price because you are owner-managed. How does that change your perspective on the budget?

Kesterton (Thomas Miller): We’ve just changed from partnership to company status. We’ve distributed equity to the employees. The most frustrating thing for our business is not having the information available quickly enough because of the time it takes to crank the machine. It’s very frustrating dealing with that: only a few managers buy into the process. Now there is more focus on the value of the business because we are starting to build up stakes that we can take away with us when we go, rather than having the old partnership. There will be more demand from our people for better information and what that means to our share price.

Simon (Deloitte & Touche): I think it’s true across most modern large partnerships that they look at themselves as a corporate legal constitution – everything is run on corporate lines – therefore we attribute a value to today’s business and are particularly conscious of what the business would be worth if it was in the public domain.

McLaughlin (Linklaters & Alliance): Because we distribute all profit, the budget goes through a rollercoaster exercise for about six months. As it gets closer to this crucial weekend, then the focus is purely on next year’s slice and the question is ‘How much am I going to make?’

Morley (St Ives): I don’t think the market is necessarily looking for a budget – it’s looking for a strategy, and I think it’s an interesting challenge to set down the strategy for the business and try and write it without putting a single number down. And I think you can actually learn quite a lot from that process.

Hewitt (Corus): With 66,000 employees, I don’t entirely agree with you that finance is heavily involved from the lowest level up. When you get to the top the finance director isn’t bothered by Joe Bloggs down there: he’s concerned with what’s happening in the City, what the share price is, how are we going to manage expectations.

Financial Director: I take your point but let’s put the question in a different way: is it right that someone should say ‘I’ve got this great wodge of training budget to use up so I better start sending people on courses now because I’ll lose it next year if I don’t spend it’? It’s not a very mature way to run a business – but whose fault is it?

Kesterton (Thomas Miller): It’s a head office culture: a control culture that says ‘I’m going to measure you on what you spent last year’. It’s a sad way to run a business.

Morley (St Ives): I haven’t seen that culture in my experience.

Kesterton (Thomas Miller): Surely it’s that fear that, if I don’t get the budget in this year, I won’t get the same next year.

Sewell (NatWest Life): And you know how much difficulty you’ll have getting something through next year if it isn’t budgeted!

Hewitt (Corus): Part of the problem where British Steel is concerned, coming from an old nationalised industry, is that everything was controlled through government, and if you didn’t spend it then you wouldn’t get it next year. There’s a bit of history there which still lies with people.

Kesterton (Thomas Miller): In that sort of environment it’s difficult to change their behaviour pattern. Maybe bringing in new people will help.

Simon (Deloitte & Touche): I think there has been a lot in the media about finance directors needing to be more proactive and needing to be business managers. The difficulty has been that they haven’t had the toolset to deliver what they want to deliver.

Jehle (Comshare): We are probably in a unique and lucky situation because, being in the technology business, we’ve got a good set of tools we use for budgeting and forecasting. We’ve tried to take those tools and make the budgeting process more meaningful: we’ve tried to get information into the hands of people more readily, we’ve tried to get our budgets widely deployed, and we’ve tried to make it a real business process rather than just a numbers-collection process. We’ve been able to use the tools to good effect.

Simon (Deloitte & Touche): There are two things I see Web technology delivering: first of all it’s engaging more people within the business process, so that must improve the quality of information. The second thing is that being able to deploy it more widely means you are engaging people with different backgrounds – so it’s not just confined to the accountants: you are talking to the production director, technical director, marketing director, and other managers, so you get a more complete picture. At last we’re getting the technology that supports the spirit of what budgeting and forecasting is about.

Jehle (Comshare): We recently went to a completely Web-based approach. Previously, we used a client-server approach and we found it very difficult to keep current information on people’s desktops.

Financial Director: The dot.com phenomena is going to affect everyone, ultimately. Will the pace of change in our businesses compel us to say that traditional budgets are simply not working?

Sewell (NatWest Life): We need to be technologically-focused and have a greater recognition that you simply can’t keep running the business on a one-year cycle.

McLaughlin (Linklaters & Alliance): I agree. We have to have a vision of the next three-to-five years, which is the fundamental bedrock of the direction we are going in. I think we still need to have a budget – a much faster one – that we can do in four weeks and then have the ability to flex as we go through the year. But you still need the budget as that bedrock to measure those opportunities as they arise. I can’t see we would ever throw the whole budget out of the window and just work on some sort of flexed forecast. Individuals would have no sense of ownership or responsibility.

Dix (CCF Charterhouse): Web technology isn’t going to change the budget per se, just the delivery of it. It’s just another tool, like the spreadsheet, that in the mid-80s became a different way that accountants worked.

Simon (Deloitte & Touche): The Web is moving so fast that we are actually in danger of not being able to budget and forecast fast enough to anticipate events. It’s a very real danger for a lot of traditional businesses.

Sewell (NatWest Life): Technology-based companies tend to be run by whizz-kids who are entrepreneurial and dynamic, whereas finance people tend to be much more conservative in nature and tend to follow rather than lead. We are still using budgeting techniques that we used in the late-80s. That’s where we feel most comfortable and we always fall back to that rather than sticking our necks out and taking risks.

Simon (Deloitte & Touche): I think the mature businesses will outlive the dot.coms. If you’ve got a dot.com such as Amazon verses WH Smith, my money is on WH Smith because those mature skills built up over hundreds of years are what’s going to count.

Dix (CCF Charterhouse): It’s not the budgeting process that’s going to make these companies survive, it’s their strategy.

Jehle (Comshare): I think one of the biggest challenges is really the whole management process. It’s easier to focus on the problem, but focusing on the solution can be a lot tougher. When things are going better than expected or there is a new opportunity, that’s easier than dealing with things that are going worse than expected.

Hewitt (Corus): Surely technology can only help in providing a tool for accountants and finance controllers to be able to provide analysis to management. We should be moving away from this hard-core beancounting transactional accounting towards the analysis work. Operational management is fine and they should be involved, but they are turning to other people to provide the information to them. And generally it comes down to the finance people to provide that information. So if technology can help, then let’s use it.

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