Budgeting: Why do the best laid plans fail for SMEs?

Ease of Doing Business for MSMEs: Budgeting is an opportunity for the leadership to lay out expectations, Department Heads to assess ground realities and put together plans for the upcoming financial year and for finance teams to burn the midnight oil to put together the budget numbers.

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It is seen that about eight out of 10 companies fail to meet their budgets.

By SVenkat

Ease of Doing Business for MSMEs: It’s that time of the year.  The budgeting process in every company comes with a mixed bag of emotions – hope, aspirations and at times trepidation about the future; a sense of perspective at the year gone by and often a sense of déjà vu: one more year, one more planning exercise. 

Budgeting is an opportunity for the leadership to lay out expectations, Department Heads to assess ground realities and put together plans for the upcoming financial year and for finance teams to burn the midnight oil to put together the budget numbers.  Having had the opportunity of seeing the budgeting process up close for a few hundred companies, it might be fair to say that in general, about eight out of 10 companies fail to meet their budgets. So, one needs to ask when is the budgeting process a failure. It would either be an execution failure: when the planning is right but the business fails to execute the plan well or it would be a planning failure: when the underlying assumptions behind the plan itself are wrong. Let us deep dive into three key reasons why Budgets often fail at SMEs:

Inadequate focus on business levers

Too often, budgets are about end outcomes: revenues, costs, profits and cashflows but it should not be the case. An unfortunate but common philosophy behind determining budgets is — “Let’s take a 20 per cent increase on last year’s revenue numbers and assume gross margin improvement of one per cent”.  Needless to say, this approach is not just incorrect but also misses out on the whole point of budgeting as a planning tool.  Most SMEs fail to spend adequate time on the business levers that drive the financial outcomes.  For example:  when budgeting for revenue, it is important to look at (a) volume-price analysis (b) customer retention and upsell ratios (c) share of pocket analysis (d) product mix (e) channel mix (f) geography mix (g) organisation design for the sales team (h) sales team incentivisation plans (i) competitive actions and trends, and (j) impact of regulation amongst others.

Scenarios need to be built for each of these dimensions before a view emerges on the ‘right target’ to take on in the Budget.  Similarly, when budgeting for say travel costs, several companies simply take a percentage of revenue.  The correct way for estimating costs for leadership and HOD travel would be to (a) estimate the number of trips by location during the year (b) look at recent trends of airfare and also factor in price moves on account of seasonality during the year (c) plan for the number of days stayed outside office (d) take into account average room rent and F&B costs. For travel by sales persons, take into account (a) number of salespeople (b) beat coverage, i.e. number of trips made (c) average tour cost per beat trip (d) impact of new hires ( e) impact of product launches or new geography expansion on the beat routes (f) impact of fuel price movements etc. Without this level of detailing, budgets remain superficial and simplistic.

Also Read: Dynamics of a successful CEO CFO partnership

Directives from the top

Several companies make the error of going with the ‘targets given by management’.  Sure, given the strategic perspective and grasp on the direction of the business, a leadership-driven top-down view is a valid and important way of putting together the budget. However, it is equally important to take into account practical constraints and challenges faced by teams on the ground, and put together a ‘bottoms up’ view of the budget. When both approaches are followed, there will invariably be a gap – the gap between what the leadership thinks is desirable and what the operating teams think is achievable. The realistic scenario is probably somewhere in between. 

SMEs that foster a culture of openness and transparency with a free flow of data and opinions between teams find a way of reconciling these two views. Leadership team members that are hands-on and spend adequate time in the market and with their teams find it easier to reconcile the ‘gap’ between top-down and bottoms-up approach.

A major flaw in the top-down approach is that plans lack the buy-in by operating teams.  Very often we see operating teams ‘nodding their heads’ at time when targets are given to them, only to come back 5-6 months into the year saying that the targets cannot be met. This is the single biggest reason why many companies end up achieving as low as 65-80% of their budgeted revenue and profit numbers.  SMEs that ensure operating teams’ buy-in, also find it easier to design and implement variable incentive packages linked to KPIs, the latter having been drawn up by the operating teams themselves. This greatly helps in aligning the teams’ interests with that of leadership and the company.

Also Read: How can an SME business owner build a resilient business with the help of a CFO

Lack of performance monitoring mechanisms

Another key reason why budgeting processes fail, post the planning at the start of the year, is the lack of timely, complete, relevant and adequately detailed ongoing monitoring of metrics.  A budget is doomed to failure if the metrics that are being budgeted are not capable of being tracked during the year. For instance, if real-time customer-level outstanding report is not available to the sales team, how will the budgeted Days Sales Outstanding (DSO) ever be achieved? In a services business, if manpower utilisation is not tracked, how will customer-level profitability be tracked and how will gross margin budgets be achieved? 

There are several affordable technology tools now available that provide real-time visibility into business metrics that allow operating teams to take real-time actions. The days of waiting for reports from Finance are long gone.  Discipline is key in ensuring timely and accurate entry of data, for correct metrics to be reported.  These are process-related issues that need careful attention; something that is often ignored during the budgeting process. 

No business is perfect.  What distinguishes a great SME from an average one is the ability of the former to take timely decisions, course correct and pivot quickly. SMEs that have good monitoring mechanisms have a better ability to achieve their budgets.

Wishing you all success in achieving your budgets, as you embark on another exciting year!

SVenkat is the founder of the performance improvement consulting firm Practus. Views expressed are the author’s own.

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First published on: 01-04-2023 at 10:47 IST