Over the years I have conducted many due-diligence projects for a wide variety of businesses and there seems to be a common thread among senior executives with comments such as:
‘Our business is growing in sales with the outlook of this growth to continue. What I can’t understand is why we struggle for cash flow?’
And when I look closely at the P&L including the Balance Sheet, the businesses are invariably funding the growth out of cash flow. This is a very tenuous method of management which very seldom works unless the business has huge profit margins which could well make them noncompetitive in the long run.
There is also an absence of proper budgeting and/or cash flow analysis along with meaningful KPI’s which would form the basis of daily/weekly/monthly and yearly operational performance measures. These operational performance measures are what I classed as the ‘VITAL SIGNS’ of the business and of course they hold the answers to ultimate failure and/or success.
Most of the work of budgeting revolves around costs which can be packaged in 4 important areas of control:
- The type of costs the business will incur and the way you group the costs.
- The important relationship of these costs and how they are classed either as direct costs or indirect costs. Direct Costs are those which add value to he product and/or business whilst indirect costs are overheads. I have always advised businesses to constantly review costs and wherever practical make indirect costs direct.
- Cost drivers are fundamental to understand and plan all work
- Costs need to be estimated and structured right
It is important for managers and relevant staff to know what drives costs and these need to be planned and budgeted intelligently. Knowledge of cost drivers is also crucial in evaluating any changes during the budget process or the budget year where any adverse trends can be quickly identified and rectified.
It is also critical to the budgetary planning process that you will need to deal with a certain level of uncertainty. This is where you base forward thinking on well thought out assumptions which become powerful tools in overcoming the effects of the unknown, be they environmental, government regulations, or any outside factors which could have a significant impact on the business but over which the company has no control or influence.
A budget process based on good planning will tell you how many products must be made to not only break-even but to progress into acceptable and sustainable profit. This combined with numerically predicted revenue, expenses and capital expenditures will establish a part of your strategic business plan that will guide operational performances at sustainable best practice levels.
No matter how big or small your business is or even what the core product of the business is, budgets and performance measurement must be a deeply entrenched Critical Success Factor which is also linked to Job Descriptions where levels of accountability are matched with levels of authority.