Business units are intimately involved in this process, providing a constant flow of data on sales and expenses. Armed with this information, Vorchheimer says he can “bet the winners,” pulling money from one area that is stuck in the mud and giving it to a more fleet-footed unit for product development, advertising, or promotional uses. “You’re trying to continually optimize the mix of where you’re putting your discretionary investments,” he says. “Previously, the business units were committed to this arbitrary annual number in the budget and were of the mind-set that they had to stick to it. Now, every division has a target, and it is our job in finance to continually help them reach it.”
Another, much smaller company, Norton Lilly International, has also traded its budget for a rolling forecast. “When we did our last budget [in 2009], we looked back at the end of the year and compared our actual performance versus the forecast, and if there were any lingering questions over the efficacy of the budget, they went away then,” says Jim Burton, CFO and chief operating officer of the independent shipping agency, with 2010 revenues of more than $50 million.
Last year Norton Lilly adopted a rolling 12-month forecast of revenues and pretax margin goals — the costs that business units must commit to based on anticipated revenues. While business-unit leaders are still held to an annual margin goal, “every unit has to make a certain margin each quarter, which is then combined at the corporate level,” Burton explains. “It is up to them to control their top line and their expenses. Each month they must report to me on their dashboards the assumptions they made about the business, revenue, and costs, and then follow up on related performance — did things play out the way they thought, or has something changed?”
If it looks like a business unit will fall short of the margin goal, its leader is responsible for creating a contingency plan, such as cost-structure changes. “I’m fine with them flying first-class so long as they make the margin,” Burton says. “But if the dashboard is lighting up red and it looks like they’re not going to, then they’d better fly coach.”
No More Sandbagging
Statoil, the large Norwegian oil-and-gas producer, decided to abolish the traditional annual budget in 2005. “We still do what the budget unsuccessfully tried to do for us: target-setting, forecasting, and resource allocation,” says Bjarte Bogsnes, vice president of performance-management development. “We used to try to force these three purposes into one set of budget numbers, which created serious problems. For example, how can you expect an unbiased sales forecast from a sales manager if that number also will become a target? And how can you expect unbiased cost or investment forecasts from the organization if those forecasts also serve as an application for resources, and everybody sandbags?”
Separating the three decisions has enabled the company to set targets that are more ambitious, intelligent, and motivating, says Bogsnes. As a result, the forecasts are less biased, and resource allocation is more dynamic and self-regulating. “The ‘bank’ is open 12 months a year, not just six weeks in the fall,” he says. “By making resource decisions as late as possible instead of in an annual budget, we have better information — not just about project attractiveness but also about our capacity to fund or man new projects.”