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From Budgeting To Strategic Planning
In
San Francisco and Australia I was a 22-year-old management consultant just
out of college. A senior partner instruct us to “loosen our grip on
the truth.” My, how we puzzled over that! Weren’t we totally
evidence-based, busting apart our client’s cherished myths? What the
partner meant was that we needed to focus on larger truths, and every last
detail wasn’t important to tell the high level story. And this leads
us to a topic I run into frequently: the difference between a budget
and a strategic plan. In essence, he was doing strategic planning,
and we couldn’t let go of the “truth” of budgeting. The reality is
that both are important tools, and the problem comes when you try to use
the one for the other’s purpose.
Here’s
a table that compares how the two disciplines approach the critical
financial areas:
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Budgeting
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Forecasting
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Revenue
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Budgeting
revenue involves known products & services. You might be
rollout out some new product, but mostly you have known products being
sold from known locations. Revenue change is typically incremental
with a % growth input.
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Typically
involves new products, services and locations. Sometimes a mix of
existing ventures and new ventures. Almost always metric driven and
constrained by market size, market share, penetration, and pricing
limits. Driven by sales rep counts, marketing spend, market rollouts,
etc.
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Expenses
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Most
corporate budgets are all about having incredibly detailed budgets for
every department. Headcount plans are done to great detail.
Typically account detail runs from many dozens to hundreds of
lines.
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Expenses
in strategic planning models are typically given short shrift because the
focus is on the sexier topics of revenue, capex,
and capital. Often the details are poorly understood. Often
estimates are done against industry benchmarks for EBITDA
profitability. Typically expenses are driven dynamically so as
revenue and volume units change, the expenses change as well.
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Capex
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Capital
budgets are prepared for known and approved projects with costs in a
tight band.
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For
capital-intensive businesses there is typically lots of effort
here. Capex and be planned to greater
detail in advance than Opex and vendors,
looking to make big sales, are happy to provide extensive input. In
non-capital-intensive businesses, $/HC can be sufficient.
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Balance
Sheet
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Balance
sheet forecasts are rarely done as part of corporate budgeting.
When considered, the base assumption is that working capital will be
about the same as last year. Very little energy put into this
section.
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In
strategic plan working capital can be very important because it can
directly change the capital requirements.
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Capital
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Capital
is rarely considered in corporate budgets. After all, capital is
fixed in the short term. Sometimes a LOC provides liquidity.
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Strategic
models lavish attention on the capital structure. Indeed, a primary
purpose of a strategic model is to answer, “how much will we
need? What returns does this generate?” Often have extensive
input options for scale, terms, and timing of debt, scale and timing of
equity, and cap table impacts.
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Goal
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Organizational
control & short-term benchmarking
Board
wants high probability that budget is close to reality.
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Setting
& communicating vision
Selling
Debt and Equity
Boards
typically do not expect everything in the strategic plan to come true;
i.e. the consider Y1 to be more likely than Y5.
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So
the problems of using a budget for a strategic plan are commonly:
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It’s inflexible and hard to add products in the growth trajectory
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It demands hardcoded inputs instead of metrics
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Only set to do one year, not five years
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Not set up to do complex capital expenditure calcs
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Insufficient complexity to handle a changing cap structure
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Very little balance sheet and cash flow statement abilities in
general
And
on the flip side, while this happens much less frequently, the problems of
using a strategic plan as a budget are:
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Insufficient time period detail (most strategic plans don’t go to a monthly
level)
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Expenses done at too high a level
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Not set up to handle multiple departments
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Doesn’t integrate well with the accounting system and therefore hard to
product budget vs. actual reports.
Clearly
these functions are different enough that they require different
tools. I’m sure my readers aren’t the ones trying to cram a square
peg into a round hole!
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