Can Shortening the Budget Cycle Increase a Company's Flexibility?

by Brian Hill

Corporations often use a formalized budgeting process that is undertaken at approximately the same time each year. The budget, or plan as it is also called, forecasts the financial performance of the company for a certain amount of time, usually one year but sometimes a longer period, up to three or even five years. The length of time the budget covers is called the budget cycle. There are times when a company elects to shorten the budget cycle.

Experiencing Exponential Growth

A company that is enjoying phenomenal growth in revenues may have difficulty accurately forecasting a full 12 months out, let alone for a three-year time frame. Rapidly increasing sales means much greater transaction volume and more staff hours required for tasks such as filling and shipping orders. In a high-growth environment the company's management may find that three months into the budget period they have underestimated the human resources needed. One solution would be to re-forecast -- adjust the budget -- every three months. This shorter budget cycle allows the company to be more flexible with its spending plans and quickly deploy resources to take advantage of new revenue opportunities.

Sensitive to Economic Factors

Some companies' financial performance is greatly affected by external economic factors. Companies in transportation industries, such as airlines, can be negatively impacted by an unexpected jump in fuel prices. Other companies are sensitive to changes in interest rates, such as manufacturing companies that borrow money to fund inventory purchases. In times when these economic factors are unusually volatile, the company's budget can quickly become outdated. Shortfalls in cash flow can result from the cost of fuel or the cost of borrowing being higher than expected. To keep the company on track toward projected profitability, reductions in other expense categories may have to be made. The shorter budget cycle allows the company to react more quickly to the shortfalls and minimize the bottom line impact.

Early Stage Companies

For start-up and early stage companies, the forecasting process involves a lot of guesswork about how quickly sales will grow and what expenses are likely to be. Managers of early stage companies accept the fact that actual results will vary considerably from forecast. These large variances bring about the risk that the company may run out of capital before revenues are high enough for it to reach positive cash flow. The shorter budgeting cycle allows the company to see the impact on its cash position if the variances continue. If it looks like the cash shortfall will be serious, spending plans can be curtailed.

Turnaround Situations

A turnaround situation usually means that the company is losing money, or at the very least experiencing a decline in sales volume that will eventually lead to losses. For the managers of the company, carefully monitoring the cash position is critical. If the company cannot meet all of its important obligations, such as payroll and rent, it could go out of business. In extreme cases like this, the budget cycle may be month-to-month. Expenditures for the upcoming month will be no greater than the forecast revenues for the month. A turnaround company does not have the luxury of planning 12 months in advance. Paying next month's bills becomes the focus.

References

  • "Financial Management 101: Get a Grip on Your Business Numbers"; Angie Mohr; 2007

About the Author

Brian Hill is the author of four popular business and finance books: "The Making of a Bestseller," "Inside Secrets to Venture Capital," "Attracting Capital from Angels" and his latest book, published in 2013, "The Pocket Small Business Owner's Guide to Business Plans."

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