August, it has been said, is the Sunday of summer. Relaxation gives way to a muted but growing anxiety about the demands of September as the workforce slowly marches back into business-as-usual mode. For no one is that more true than the CFO, as August marks the entrance to primetime budgeting season.

And nowhere is that season more critical than in a private equity environment. Not only is the accuracy of the budgeting process critical to compensation plans and debt covenant analysis (an area in which “surprise” is a four-letter word), it’s also critical to the fund sponsor whose demands of budget granularity require heightened resources and investment.

The importance of the budget for a PE-backed company cannot be overstated. When done well, it’s an efficient process that:

  • Highlights opportunities for profitability improvement and growth acceleration;
  • Measures the success of value-creation initiatives and progress toward investment theses; and
  • Provides a balance between stretch goals and related compensation plans on the one hand, and true visibility into the coming year on the other.

More often, however, the budget is a bandwidth burden that falls far short of exploiting those opportunities.

Despite its importance — or perhaps because of it – the budgeting process seems bathed in corporate lores, legends, and myths — some of which have merit, many of which do not. Separating budget fact from fiction is the key to getting the most out of the process. Here we assess the top four budget-season myths for accuracy:

Hal Polley

Hal Polley

Zero-Based Budgeting Is An All Or Nothing Game. If you’re a fund sponsor, the term zero-based budgeting (ZBB) makes your heart swoon. If you’re a PE-backed CFO, it’s less heart swell and more heartburn. In either case, the term is frequently misunderstood or misused and, because of that, it can be an opportunity missed.

Introduced in the 1970s, ZBB is a process of budgeting that requires managers to build their budgets from zero on an annual basis. ZBB employs a complex methodology wherein finance breaks costs into decision packages, assigns each package two owners with differing perspectives, and requires decision-makers to force-rank priorities. ZBB’s focus on exposing and eliminating unproductive costs and understanding cost drivers has earned it a renaissance of late, particularly among cost-focused private equity firms that seek more sophisticated value creation tools.

The benefits it offers in a PE-environment, with its finite investment horizons, are plentiful:

  • Mission Focus: Achieves a well-justified budget aligned to strategy rather than history.
  • Cost Reduction: Avoids “automatic” budgetary increases.
  • Alternative Analysis: Improves operational efficiency via a rigorous challenge of assumptions.
  • Communication: Increases inter- and intra-department coordination.

But, ZBB is extremely bandwidth-intensive and extraordinarily complex. It requires a deep bench with specific skill-sets that take time to acquire. So, fund sponsors tend to lean in, while CFOs prefer to lean out.

The mistake both make is assuming that ZBB is a zero-sum game. It needn’t be an all-in scenario: many of its principles can be borrowed and applied to certain costs in most businesses. (It’s particularly applicable to costs that are not directly related to revenue and businesses that are the result of various mergers or spinouts from larger corporate entities). Leveraging some of ZBB’s core concepts (like decision units and decision packages) can force the organization to think about alternative ways to perform functions without burdening the business with some of ZBB’s labor-adding exercises. Think of it as ZBB-light: Same great taste, sans the heartburn.

The (Budget) World Is Flat: OK, so this one might have fallen out of favor around the time of Columbus, but you’d be surprised how many finance functions have either forgotten both elementary history and math or simply don’t realize its application. The corporate world is a sphere, not a circle. As such, the finance function needs to take a multi-dimensional approach to budget creation and budget review — dismissing assumptions based on automatic annual adjustments and instead “reality checking” numbers from multiple angles.

That means that budget creation must begin with a build-up of both revenue and expense drivers. On the former, that includes granular assumptions on areas such as sales team effectiveness and pricing, pipeline, bookings and backlog, and revenue realization across relevant dimensions (e.g., product, customer, region). On the latter, t’s a process that includes expense assumptions by product, by channel, implementation costs, commission structures, travel and entertainment, events, and training.

The world is flat approach ends there. Conversely, the spherical process has only just begun, starting with a multi-dimensional analysis and refinement of the budget, that:

  • Analyzes historical patterns and risk-adjusts numbers;
  • Doubles down on granularity (by ensuring assumptions are built “bottom up”);
  • Benchmarks against competitors and the overall market (growth rate, market share, wallet share, pricing, etc.); and
  • Pressure tests with challenge scenarios.

The flat approach relies heavily on assumptions — and you know what they say about assumptions.

The Budget Process Is Hampered By Too Little Data. Survey says no. In fact, if anything, CFOs suffer from too much data: too many competing golden sources of truth create one big falsehood.

Reconciling data is a critical part of any budgeting process, but it’s even more critical in a PE-backed environment wherein investment theses are often built around synergy realization or serial acquisition (add-ons). Having the right sources of data to understand redundancies and capture them within the budget can be the key to realizing a return on an investment thesis. Having to do so with a disparate technology infrastructure inherited from constant M&A activity can be nearly impossible.

As a result, finance will need to hone its tech skills during the budgeting process: the focus must be on building platforms that enable integration and integrity, thereby solving for too many data sources. Technology supporting the budgetary process should also enable flexible analysis (line-item detail, ongoing adjustments, what-if analysis, and on-the-fly dimensional analysis). The key here is to not make data reconciliation the end goal. Instead of spending time pulling data together, the CFO must (eventually) spend time building plans from it.

Finance as Bad Cop. Yes, CFOs often take the heat given their role designing the budget process, enforcing the hard deadlines, asking the difficult questions, and challenging the business to rethink priorities. But that doesn’t mean there’s not a good cop role for finance to play as well.

Making business leaders interactive partners in the budgeting process and making clear what everyone has to gain can make an effective budget a shared goal worthy of the time investment. But, the smart CFO knows that’s the easy stuff. Arming department heads with enough skin in the game to make cuts worth their while — either because of broader reputation or in favor of investments that will lift all corporate sails — is where the real rubber meets the road. It is here where the strategic CFO can take budgetary hardships and turn them into strategic partnerships with business leaders. Taking time to determine the right answers means rewarding comp plans and overall corporate success — the latter usually a key incentive for operational leaders.

So while the rest of us plan for the end of long days spent in the sun, CFOs are preparing for the start of long days spent in (insert the name of your budgeting software here). Those budgeting at PE-backed companies will have even longer days.

The most innovative CFOs will try to improve the inevitably long process by assessing new budgetary techniques. They will be astute enough to adopt, where appropriate, portions of new techniques; accept, where appropriate, advancements in best practices; and reject, as appropriate, the myths that encumber an already overly burdened and under-resourced budgetary season.

Hal Polley is managing director and head of strategic finance at Accordion Partners. Accordion is a financial consulting firm focused on executing value-creation initiatives for private equity firms at their portfolio companies, particularly within strategic finance, performance improvement, and financial accounting and advisory services.

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