Budgets matter

Henry is an electrical contractor that provides residential electrical installation services as well as maintenance and repair services.  He has almost 50 employees working in the business and they are divided into two teams:  residential construction and services.  Each employee has a truck and Henry has an estimator that responds to tenders and customer quotations.  Henry hired a management accountant recently and built a forecast and budget for each division along with his administrative department.  With tighter budgets he was well on the way to earning targeted profits.  In fact, the business was enjoying a significant upturn in sales and Henry was very busy buying more trucks, hiring new employees.  None of this growth was expected when he built his financial plan and budgets and halfway through the year, he realized that his costs had crept up, his overheads and jumped significantly and his profits were down.  Henry was frustrated, the entire budgeting process was a total waste of time and money – in his view, budgeting is useless, why bother?

Budgets don’t control costs – people do!

Henry’s budget did not account for a possible growth in business and consequently, Henry stopped paying attention to the key rules that he had used to create his budgets. With such an upturn in business, he should have reformulated the budget to identify what additional costs would need to be incurred before embarking on a mad spending spree to meet sales targets.  Furthermore, with so much money on the orderbook, Henry anticipated that the cash would come in faster, but in fact the collections slowed down (larger jobs resulted in longer billing delays and longer customer payment cycles).  The responsibility to manage and prevent over purchasing, the lack of purchase order systems to control costs and the means to enforce budget compliance were not built into Henry’s finance processes.  In addition, his finance reports did not provide Henry with the early warning systems to highlight where costs might be getting out of control.

To fix this Henry realized that a “budget” was just a number on a page – it meant nothing unless his managers understood that there were limits on spending and that there would be enforcement to comply with spending overruns.  Henry’s accounting team collaborated with the managers to develop realistic spending plans and then put in additional controls – purchase orders were used to ensure that purchases were job related or within budget controls, credit card policies were put in place to prevent random spending, and any purchases above $2,000 needed managerial approval.  Finally, if managers were over-spending they were consulted to determine if budgets needed to be refined or to limit future spending.  Henry used his new management reports to provide a forward-looking view and early warning systems of possible challenges that lay ahead.

Set up dashboards to provide an early warning system.