Posts Tagged 'Budget'

June 10, 2009

Medieval Financial Techniques in the 21st Century?

Recently I had the chance to attend the annual Beyond Budgeting Round Table (BBRT) conference to help me keep up on my CPE credits. Those darn accounting licenses have to be maintained, ya know.

I was pleasantly surprised at the conference that SoftLayer was already doing the crux of what this group preaches – namely, that assembling an annual budget and trying to live by it is a colossal waste of time!

One speaker pointed out that budgeting originated back in medieval times long before the Industrial Revolution. During those days, the feudal system was the order of the day. Landowners allowed people to live on their land and raise crops. Once per year, when the harvest came in, the landowners received payment from the people living on the land in the form of a share of the crops or a share of the gold for which the crops were sold. Since the landowners were paid once per year, they had to plan how to make their annual payday last for a whole year. You guessed it – this plan was called “the budget.”

Unfortunately, most companies and organizations today use this horribly outdated financial management technique to run their business in the fast-paced information age economy of today. In most cases, this just flat doesn’t work.

For example, one of the speakers was the CFO of a very large healthcare organization. He said that back in the days when they produced an annual budget, there were 240 budget managers that spent 90 days of full-time effort to produce the annual budget. That equates to 60 man-labor years of total time to produce that budget. If you assume that each of those managers averages $50K per year in compensation, the cost of producing that budget is $3 million. What’s worse is that the CFO said it was worthless before the final version was printed because it was built on stale fundamental assumptions that were several months old.

Once these obsolete documents are produced, they become static financial contracts. They limit spending for each department, and this isn’t always a good thing. Some departments may see some fantastic market opportunities develop halfway through the year, but they can do nothing to take advantage of them because they would exceed their budget. On the other hand, some departments can be allotted too much money, so they go on wasteful spending sprees at year end to be sure and use up their budget or else lose that funding next year. People often ask for permission to exceed budget, but usually no one gives back any unused budget dollars. Even worse, management compensation is often tied to these obsolete financial contracts. Business schools are awash with case studies of bad business decisions that were made to maximize bonus compensation in relation to the budget.

From the beginning, SoftLayer realized the futility of producing an annual budget. In the rapidly developing business of web hosting, the landscape can dramatically change much more quickly than an annual cycle. So we implemented the policy of maintaining a rolling forecast that is updated to the best of our current knowledge each and every month. This practice has served us well, and is one of the “best practices” adopted by the BBRT.

Another best practice recommended by BBRT is to maintain multiple forecast scenarios that factor in macroeconomic possibilities. Then as reality develops, you have a better handle on the tactics to implement because you now know what most of these decisions should be in advance. At SL, we will be implementing the multiple scenario practice over this summer.

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