Budgetting: confront the myths, build a true plan; the budgeting process contains many myths and sacred cows. Now is the time to move beyond them and use budgeting techniques that really work.

The corporate silly season budgeting is nearly here. As summer turns to fall in the Northern Hemisphere and winter turns to spring in the Southern Hemisphere, people will devote many hours to predicting and planning the financial landscape tier 2004. Much of this planning is a huge waste of time--instantly obsolete when something unplanned arises in mid-January. This article is neither a treatise on generally accepted accounting practices (GAAP) nor a survey of how various entities execute the budgeting process. Instead, it adds reality by application of practicality and common sense to a process that has largely become a time wasting exercise in fiction whose only purpose seems to be endowing an air of respectability to palm reading.

Readers of my earlier writings will recall that I regularly and poetically promote the idea of keeping the invoice printer humming while slowing the check writer as much as possible. These concepts--amazingly ignored by many--are among the first to consider" when budgeting at any level of a corporation, from mill level on up.

Another flaw is approaching the budgeting process using a profit and loss (P&L) statement as a guideline for the exercise. A P&L statement essentially has a top line for income followed by a myriad of details for expenses. The usual methodology of the exercise demands that the marketing and sales department supply the top line while everyone else fusses over the expense details. The most successful enterprises I have seen demand as much validation from the marketing and sales department as they do from the balance of the business.

Then they go one step further. They avoid bifurcation of the entire process by throwing leadership from all parts of the business together to challenge and probe each number. In other words, leadership from operations actively probes the justification of the top line while leadership from marketing and sales actively probes and challenges the expense side. The total organization therefore develops and approves the entire budget. This provides alternative plans and contingency insurance for that unforeseen surprise in the second week of January--an increase in natural gas prices or a drop in sales price--that often tosses the entire budget out the window.

BENCHMARKING

In the last decade or so, another fallacy has crept into the process. This is the idea of benchmarking performance against competitors. As former competitors became sister mills, one enlightening aspect of the mergers and acquisitions of recent years has been the discovery that benchmarks one group applied to the other proved highly erroneous. At least two different senior managers from two of the top five pulp and paper companies in the United States have confessed to me how erroneous their previous assumptions were concerning mills now in their organizations, I can summarize this as follows. If you have solid, detailed data about a competitor, someone probably obtained it in a manner that borders on or is industrial espionage. If it does not have this quality, it is probably worthless. Follow the example of professional golfers. Benchmark against yourself and your sister mills since this is the only legal and reliable data you can obtain.

A final problem in the budgeting process is the obvious conflict of interests of the participants. You know how it works. The individual divisional or departmental leadership involved is quick to criticize and cut expense numbers of other participants when considering the expense side of the budget while vigorously defending their numbers. This is a horrendous conflict of interest, but the ones executing the budget must obviously be responsible for creating it.

Applying creative thinking provides the only way to break this pattern. Offer each budgeting leader an immediate one-year salary and benefits severance package if they can conclusively prove to the satisfaction of the remainder of the team that they can eliminate the functions of their position permanently. If they can eliminate their entire department using the same criteria, give them a two-year package and fully fund their retirement. This is the only way I know to crack the conflict of interests pervasive in the process. Appealing to their professional fiduciary duty simply does not work.

BUDGETING PROCESS

With these benchmarks in place, companies can now proceed with the activity of budgeting. Although I cautioned against the bifurcation of the sales and marketing vs. the expense side of the budget, separately direct each side to do some preliminary work. An admonition at this point is to instruct each side to build their information from data that has a solid foundation. On the sales side, assist the leaders in gathering this from national and international data collections put together by governments, import/export watch services, and for-profit economic agencies. On the expense side, contact all suppliers and vendors and obtain commitments for the supply of raw materials, goods, and services for the coming year. Some significant items such as prices for market pulp, energy, etc., are virtually impossible to solidify, If some prices are at probable cyclical highs, solidifying them is absolutely foolish. In most cases, procurers can do more about pricing commitments than is common practice.

Bring the team together. If you properly instruct and coach them, they will now have a solid basis for every item they contribute. You will have admonished them, encouraged them with the severance package, and admonished them again to bring forth solid data devoid of politics, guile, and more politics.

Although an earlier introduction is possible, the leadership must work to change the mindset to that of being entrepreneurial rather than bureaucratic at the start of the fully assembled team process. A bureaucratic process as practiced by most large and public companies will develop a budget using a GAAP pro forma P&L as a guideline. Toss it! That is how governments build budgets--not nimble, for-profit enterprises. Accountants can put the results into a GAAP P&L model when the entire process is complete. During budget development, do not allow such a model into the room. Instead, build a priotized waterfall based on anticipated cash flow. Regardless of business size, cash flow is king. For verification, simply read 95% of the academic and popular business tomes of the last 20 years. The financial world simply calls this model a cash flow waterfall. The team can agree on the priorities of the cash flow waterfall, but it should look like Fig. 1.

A chagrined CEO will note that he or she and the board of directors receive the "dribble" at the end. Their acumen must ensure that the end of the waterfall is not a dribble but an acceptable flow. The leaders are at that point because that is where venture capitalists put the heads of any enterprise they are funding. That is also where astute private company holders find themselves. Prudent preservation and continuation of the enterprise demands the proven priorities of this cash flow waterfall.

OTHER CATEGORIES

Consider a few important categories often subject to abuse and chicanery in recent times. The first and worst is maintenance. A properly maintained facility can suffer one or two years of sub par maintenance attention with little affect on the bottom line. By year three and beyond, a company will need to finance all the deterred expenditures. Additionally, unanticipated breakdowns will occur to dent the budget in unimagined ways. No one has yet proven conclusively that maintenance expenditures can be anything less than rate of depreciation in the long term. This is even true in other heavy capital industries, while doing the regulatory maintenance required to fly safely, Eastern Airlines managed to defer and delay everything else until bankruptcy. In the long term of three or more years, maintenance must equal depreciation unless yon plan to cease business.

Capital investment is the second category. Capital investment in the paper industry is striking in its lack of creativity, I do not mean how an investment is funded, although much unhealthy creativity in funding has existed, I mean items for which the money is spent. The pattern followed is predictable. When a supplier finally sells serial number 1 of the "Excellent Widget" to someone, everyone else wants one too. This is not a creative or optimum use of capital. This is simply copying what others are doing, it may or may not be correct for you. Nothing can substitute for solid scientific and engineering analyses that ascertain what your mill needs to optimize your unique process in the unique environment in which you operate.

Production forecasting and maintenance shutdowns go hand-in-hand but require superb cooperation among departments barely familiar with each other--sales and maintenance. Production management often serves in a buffer role in such planning. This is a mistake. All three departments--production, sales, and maintenance--need careful, face-to-face coordination during the budgeting process and throughout the year. with operating margins today, such meetings may make the difference in a particular facility between profitability and loss.

To borrow a quote, "the first shall be last." The overhead team members are not accidentally the last beneficiaries of the cash flow waterfall. If they become entrepreneurs and seek funding from venture capitalists, they will find that this is exactly the position in which these funding sources place them as noted above. Why should ownership by stockholders make any difference?

Often, executive search professionals and others will argue for high salary and benefit packages for the top management team to attract top candidates to the enterprise. This is a self-serving statement since the projected annual salary of the candidates is the basis for the fee of a search professional. To attract a candidate, I have no argument with providing an appropriately competitive first-year package. The first year is a "pass." After that, top executives must earn their keep. A properly prioritized cash flow waterfall will assure the owners of a company--the stockholders--that this is indeed happening, If an executive opts to leave due to diminished flows, a hearty bon voyage!

About the author: Jim Thompson is chairman and CEO of Tale Analytic Inter. national, Inc., Atlanta Georgia, USA. He is also a member of the TAPPI Editorial Board and writes the weekly Column "Nip Impressions" in TAPPI's weekly electronic newsletter, Over-the-Wire. Contact him at [e-mail]

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IN THIS ARTICLE, YOU WILL LEARN:

* Why many financial planning processes are a waste of time.

* Why companies should use "entrepreneurial" vs. "bureaucratic" budgeting

* Wiry sales and maintenance need to communicate

ADDITIONAL RESOURCES:

* "Corporate budgeting is broken, let's fix it" by Michael C Jensen, Harvard Business Review, pp. 94-101, November 2001.

* "Damn the budget, full speed ahead!" by Kathleen Melymuka, Cemputerworld, November 12, 2001.

* Handbook of Budgeting, 5th Edition, ISBN: 6-471 26872-0, John Wiley & Sees Inc., June 2003.