Real Numbers

by Orest J Fiume

  “There is the one budget that we do, and it’s for the bank,” Greg Flint concedes. “I spend about 15 minutes creating it because the bankers don’t really care about the budget, either. What they care about is whether we’re going to break covenants.”

  The answers will not be the same from one company to the next, so there are few absolutes except this one: If the reason for a budget is “Because we have to” or “Because we always have,” there is more work ahead for the team. At the end of the road, past the Five Whys and some serious soul-searching, however, the organization will be rewarded with a truly lean budget.

  Given the energy that has gone into defining whether a business needs a budget, and then what sort of budget might be of value, the intrinsic value of the chosen budget should be obvious. What might not be immediately obvious is the value of the budget process itself.

  When budget creation is a process undertaken as an entire company, everyone understands what resources will be available and why. In a lean organization, this becomes part of the hoshin7 process or policy deployment. If the company begins the budget cycle with the expected sales level for the coming year and concentrates on finding the resources to support it with an acceptable profit margin, for instance, the budget is not a dictator but a logical progression of a single goal. And then, with collaboration on the project, there will almost certainly be cross-germination of ideas within the company.

  7 Hoshin Kanri, part of the Toyota Production System, is a process of selecting —and deselecting —major projects to meet company goals and assigning personal responsibility.

  With that goal in mind then, let’s look to the journey. Particularly for companies that seek to increase understanding and communication, the budget process should be carefully considered and, above all, inclusive. The CFO —or any manager empowered to initiate the budget talks —should explore a variety of alternatives with a broad cross-section of people. With people talking to each other and challenging each other’s ideas, we are lead to better choices.

  Think back on the budget experiences you have participated in; consider what worked and what did not. Were the hours spent trying to get a column of numbers to add up to the “correct” amount worthwhile? Or was the discussion of how to achieve your number one project without adding more people to the staff more valuable? Was it better to figure out where to cut costs to make it believable to accounting, or was it looking at which markets had increased sales opportunity for your products? Looked at this way, it is easy to see that the budget itself is probably far less important than the journey everyone took to get there.

  Lantech begins the budget process by defining a specific business objective and then —often, but not always —the leadership breaks part or all of the company into small idea-generating teams. One year, when creating new revenue was the top business objective, the first step in the budget was asking the entire company to form small teams and develop revenue-generating ideas. Another time, productivity was the goal and so that was the assigned subject for the teams. Another year small teams were asked to focus on a variety of assigned subjects, such as kaizen project management, new product ideas, cost elimination and medical benefits costs. Kaizen techniques are used for brainstorming, and team diversity is strongly encouraged to get fresh eyes on the subject, as well as experience.

  Leading all of this in most companies will be the CFO, or someone else within the finance arena. Someone from accounting usually schedules the meetings, defines the information required and then compiles the data from each department or area for leadership to review. And it is usually accounting managers who critique and correct every manager’s numbers, pointing out all the problems: numbers too high, too low, not consistent, not justified. No wonder some people hide when they see accountants coming.

  Let’s face it, budgeting and working the numbers is not the strong suit of many managers. Yet, every year we put them in the position of figuring it out for themselves while we wait in judgment, instead of offering help.

  Rather than waiting until the end to provide an evaluation, begin with the planning process and assign one person from accounting to work with each of the various managers. Most accountants are good with spreadsheets, organizing, and doing simple math —skills that will be much valued by managers slogging through the numbers.

  If your company is organized by function or by product line, assign an assistant from accounting to each area within the established framework. In a larger company, specialists or financial analysts might fill this function. But a smaller company can achieve the same effect through thoughtful assignments: Perhaps the accountant who works with credit and collections or invoicing can work with the sales team while the accounts payable clerk works with the operations team. It might not be a perfect match every time, but no matter the match, the accounting specialist can be there to help organize information, get answers to questions and organize data into requested formats.

  The specialist should be able to easily answer or research questions that vex managers, such as how much should be planned for relocating a person? How much can we expect telephone costs to rise next year? These specialists can, in turn, help to explain to the CFO or budget manager what the data means, or how the inconsistencies came to be and help move toward resolution.

  In too many organizations, people get so caught up forecasting telecommunications bills, month-by-month, department-by-department, that they miss the big picture and the opportunities. Changing this paradigm involves a careful look at the available staff and their assignments. Make sure that your best big-picture thinkers are not breaking down utilities bills.

  Look at it this way: A budget process is like an accordion, always pulling open to include more points-of-view. Then, moving together again as decisions are made. In the first position, the accordion is compact and pushed together as managers define and understand the top-level business objectives. The accordion then expands to get wider input on possible strategies that could be used to reach the objectives. Pushed together again, executives decide on the top five or so strategies for the company. Expand to create action plans and identify resources required to meet the targets for each strategy. Pushed together, the accounting team then does the hard work that will make the process pay off by assessing whether total revenues, costs and resources to meet those strategies will be commercially successful. Expand again to resolve the gaps and issues identified, and so forth. Each expansion and coming together will get tighter, resulting in a harmonious organization, which thoroughly understands the strategies and targets.

  Be careful, however: Pull the accordion apart too far to include too much detail and an accounting department could easily find itself stretched too far. Remember, only five to ten line items are normally critical to a company’s success.

  For most companies, the largest expense items on the budget will be salaries and benefits, so it is only natural that most of the focus in a budget process falls on how many people are needed in each area. Not all staffing expenses can be planned, however. Every year, a very significant impact to the actual spending is due to people voluntarily or involuntarily leaving their jobs. When there are job openings no salary is being paid, but that little windfall probably isn’t in the budget either. Nor is the search for a new employee or the sudden need for six new clerks in customer service. There are three options for accounting:

  1) Spend time in the budget process trying to guess who will leave when (otherwise known as the crystal ball tactic)

  2) Ignore that personnel levels will change and budget for a fully staffed year, using any savings gleaned from staff shortages as a budget buffer

  3) Look at the historical performance for attrition overall and budget that factor

  Option 3 eliminates the waste and emotion of the guessing game that is implicit in option 1 and frees up funding sitting idle in option 2.

  To use option 3: If the overall attrition and related gap in salary spending is two percent in the personnel bud
get, just reduce every personnel-spending budget by two percent. Not only is this quick and easy, it is usually more accurate. It won’t be precise, but this is one of those instances when accuracy is more valuable than precision.

  Most organization staffing is based on demand for the products, plus the current understanding of how many people it takes to make that product. This is certainly true for shop floor manufacturing, and is probably also true for staffing levels in Receiving, Shipping, Engineering, Spare Parts, Support and all other departments. So, a common estimate of demand, called takt time in lean organizations, is one of the first steps in the budget process. The demand may be expressed in dollars or units; it may be organized by work cell or product line or by category. What’s most important is that product demand volume becomes the driver for staffing levels.

  Demand should be the starting point for calculating the number of people needed in each area throughout the year. To demand, add the productivity factor expected to be achieved from kaizen or other improvement efforts. If a 1-percent per-month productivity increase is expected, each area can calculate what the resource needs will be, compared to the demand for the products.

  For the truly lean organization, staffing questions present new challenges throughout the year, not just at budget time. For those businesses that have worked hard to get double-digit productivity gains and have made the commitment not to lay off any employees made redundant during improvement work —an essential promise that a lean organization makes to its employees —there may be the question of extra people. Shop-floor associates, customer service representatives, and even accounting clerks can find themselves no longer needed in their former job functions. From a practical and a budget perspective, what do you do with those people?

  Most companies quickly implement one of two choices: assignment to other positions in the company, opened by attrition, or into a labor pool. Typically, the labor pool becomes a constantly shifting team that concentrates on assisting further kaizen efforts. For instance, the labor pool might be directed to do follow-up work from an improvement team’s kaizen week while waiting for new assignments. Other freed workers —skilled machinists, for instance —might form a machine build group, creating the smaller more versatile machines that lean manufacturers embrace. A cross-functional team might be put to work on developing new products or services. These are all valuable employees now, having been trained in lean concepts and having seen the process at work firsthand, and should be employed while waiting for new positions.

  What’s important here, from an accounting and budgeting point of view, is where these employees appear on financial statements. If the freed workers’ salaries are still charged to the departments where they used to work, be aware that you will be undermining your improvement efforts. If a department makes process improvements that removes workers, but is still charged for the workers’ salaries, there will be little financial incentive to continue looking for improvements. Instead, create a new cost center specifically for your labor pool and celebrate every time the salaries in that account take a leap upwards —that number represents improvements being made in the business.

  It also gives the company a very visible sign of where associates are being freed and how many are in the pool. As new or replacement jobs open up, these are the first resources available for the job. Simultaneously, you may also have a Kaizen Promotion Office (KPO). This is the team hired specifically, or promoted from within, to run your kaizen or continuous improvement (C.I.) efforts. It is better to keep these two budgets —labor pool and KPO —separate or your KPO expenses can seem to run out of control. The KPO might direct the efforts of the labor pool, but it is usually a mistake to actually attach transitional workers to that office. Instead, keep the resource pool separate and that way, when a job needs to be filled and an associate can be plucked from the pool, you will be getting a job filled for free.

  Just as personnel issues are viewed differently in a lean environment, so are new capital requests. For decades, accounting courses have been churning out students who know exactly how to evaluate capital requests —the wrong way.

  The most important thing a CFO can do for a company is to constantly keep the big picture —the entire value chain, from raw material supplier to distributor —in mind. When evaluating capital expense requests, this means considering the needs of the process as well as the bottom line. For instance, in years past, accountants might consider three new widget makers when a new one was needed. The machine that put out the widget fastest was often considered the best deal. Even if the machine were a few thousand dollars more, so long as it ran 20 hours a day putting out thousands of widgets, it would be worth the investment. You don’t need thousands of that type of widget? Well put it in stock, against a rainy day.

  CFOs in lean environments now realize that the smaller, more flexible machine is actually needed. Perhaps the perceived per-widget cost is fractionally higher, but resources are not being wasted in the production and storage of useless widgets. And when the market changes its mind about the size and color next month, businesses want versatile machines that can adapt along with the company’s needs.

  When considering new capital expenses, the questions to be asked are:

  Will it reduce inventory?

  How much will it delay cost?

  Is it flexible? Will it easily accommodate product changes?

  Can we use a smaller, single-purpose machine —maybe one designed and built internally?

  Will it help us avoid inventory, especially the inventory that clogs up the flow between processes?

  Does it help us meet takt time?

  Smart companies no longer justify buying large equipment based on a lower per-part cost if that part must be run in big batches to achieve the savings. Excess inventory, lean executives know, clogs up communication between value chain partners — do you know if your current supplier can really deliver to your new growth expectations? —and makes responsiveness sluggish. Batch manufacturing creates costs and waste that accounting must be vigilant against, particularly while reviewing capital requests. If a cost benefit analysis is performed, the cost should be net cost: the cost of the project less any permanent inventory reductions that it will achieve. This allows for projects that trade one type of investment —inventory —for another type —capital equipment —but achieve increased capacity and flexibility to meet changing customer demands. In fact, if the permanent inventory reduction is equal to or greater than the capital investment, the project generates an immediate benefit and is self-funding.

  A capital plan typically focuses on the plant, property and equipment a company expects to need to meet the business plan. However, accounts receivable, inventory and other working capital are large users of cash and funding. Rarely do companies have top-level improvement targets here. But in a lean organization, inventory level or turns will be a key metric of success.

  Accounts receivable days outstanding can also be improved by paying close attention to customers’ compliance with sales terms. The capital savings can be fundamental to a company’s ability to grow. In the next chapter, you will see how this capital can really drive shareholder and enterprise value.

  IDENTIFY AND COMMUNICATE GOALS

  WITH A LEAN BUDGET

  Let’s say that increasing profits is your company’s goal because you need better profit margins to fund future investments or grow the business. One way to increase profits is to increase expenses at half the rate of sales. Give that goal to the teams and ask, “How would you do this?”

  One technique to use during lean budgeting that easily communicates the goal to everyone is to set an expense growth target at less than the sales growth target. For instance, if sales has identified that they think there is a 10 percent increase in sales for the next year, target increasing the expense rate at only five percent. If you have already created the Plain English Financials from Chapter 5, then focus on the natural expenses —as opposed to the variances or other fa
ncy ways to express plain numbers —that can be influenced or changed.

  Accounting can make this easier for everyone if they distribute, at the beginning of the process, a pro-forma expense budget using a five percent growth rate. This is distributed with the message that it is a starting point; not a dictate. Operations then spends energy on finding creative options or productivity gains to achieve a maximum 5 percent spending increase. The goal is to provide useful data to the departments so they don’t spend valuable time crunching numbers.

  Many lean manufacturers have identified a target of a one percent improvement per month. Instead of having this as a free-floating goal, this can be integrated into the budget process. Identify the resources currently required to do the work, then reduce that requirement by one percent each month in each category and apply that rate to your new sales level. That relationship will show you the resources needed to produce the new level of production, based on sales, including a 1 percent improvement per month.