I have had more inquiries about scheduling one of my 1 Day Assessments in the first three work days of 2010 than got in the entire month of December of 2009. This is not because of any marketing effort on my part, or any big change in the competitive landscape among my potential clients. For the most part, they seem to be coming from companies that wanted to schedule one quite a while ago but had to wait until the new year because they had used up their 2009 consulting or training budget. How ridiculous is that?
The arbitrary and often destructive practice of managing manufacturing – or just about any business for that matter - with an annual budget is one of the first things to go when a company converts to a lean accounting, lean enterprise approach. Annual budgeting is one of the relics from the past that never did make sense. In the crazy and uncertain business environment we currently face, it is downright absurd.
Manufacturing is a continuous, ongoing process and breaking it into arbitrary chunks based on a calendar is just plain silly. Your results today have precious little to do with what you are doing today, but are driven much more by the decisions you made last week, last month and last year. The cost of your manufactured products was about 90% determined when it leaves the design stage long ago - purchasing and production execution merely tweak it up or down a tad. The amount of non-value adding waste in your business and support processes is driven by the management structures and processes someone put in place long ago.
Today's results are a function of yesterday's decisions. It follows, then, that tomorrow's results are a function of today's decisions. Seeking to optimize profits today by complying with a budget some Nostradamus wannabes devised months ago does little more than to assure that profits are in trouble later – when the chickens from today's decisions come home to roost.
Breaking the business into time chunks and thinking that making sure each chunk is profitable and that adding up the chunks will result in long term success leads to all sorts of dumb things – deferring machine maintenance, putting investments in developing people and continuous improvements in business processes on hold, driving people to use vacation and sick days under 'use it or lose it' schemes, cutting product development and R&D costs, and on and on.
Failing to spend money on things that are in the best long term interests of the business because the expense was not predicted a year ago is silly. Measuring performance by tracking a dizzying array of variance types – volume variances, mix variances, spending variances, purchase price variances – against a budget is hopelessly outdated is even sillier. Paying people performance bonuses for their skill at mastering the budget game is silliest of all. It is the intellectual equivalent of knowing you took the wrong road, but continuing on it anyway so long as you are making good time and getting good gas mileage.
The SOFP process – Sales & Operations Financial Planning – is essential to restoring sanity and driving continuous improvement. It is based on having the cross functional value stream management group always looking at continuously improving short term execution on a rolling basis. What is spent is not a function of some hokey decision made a year ago, but on what it takes to assure that the future is always as good as, or better, than the past in a manner that keeps everyone focused on the same view of reality. The fact that a new year just rolled into the horizon changes nothing.
Continuous improvement is a product of continuous management, and annual budgeting is anything but continuous thinking. It is little more than attempting to navigate by looking only at the rear view mirror. Dumping annual budgeting and managing by SOFP is assuring that everyone is looking ahead, making constant little course corrections, and making sure that you are making good time and getting good gas mileage while going in the right direction.
Peter Klym says
Bill,
I wish I’d had you as a schoolteacher 30 years ago, my life would have been oh so much more clear and simple. From time to time you do come out with a masterpiece, and this is one of them.
What you don’t mention are those companies where they scurry around at the end of the year to actually spend all of their annual budget (using your examples, this would be like training people before they actually need it) because the money is gone if they don’t. In fact, when I think of it, most of the people I’ve worked for have done this to some extent.
So if I’d known you 30 years ago, I could have told them that they were all wrong!
AJ says
“The cost of your manufactured products was about 90% determined when it leaves the design stage long ago – purchasing and production execution merely tweak it up or down a tad.”
That quote alone is worth the price of admission. It’s astounding how many companies I see that either don’t see this, or abandon it at the drop of a hat.
Kevin says
Our big a-ha along these lines was a few years ago at the Lean Accounting Summit in Orlando when Steve Player said “budget to the wall”… that one phrase made us realize how crazy traditional budgeting really was. We immediately got rid of pretty much every budget with the exception of a couple used for cash flow planning… and even those became rolling instead of calendar-based.
The big unexpected benefit? The huge amounts of time freed up when the most highly paid people in the organization no longer had to spend hundreds and thousands of hours analyzing variances (let alone creating budgets in the first place that were immediately obsolete)… looking backward instead of looking forward. Companies kid themselves that looking backward will help them learn a lesson when looking forward… they end up spending so much time looking backward that they don’t have time to look forward.
Just get better and better at looking forward and making decisions on better and better current information.
Sean says
Bill,
Can you point me to some more information on the lean version of the SOFP?
Chet Frame says
Good post, Bill. We see the same thing from those companies that are still wandering through the budgeting labyrinth. Some have changed and see the difference. Some are changing and working to make a difference. Some are making good time following a GPS map that won’t get them where they want to go.
Tom says
I wish you had written this 10 years ago when I quit the company I was working for, because I refused to cooperate in preparing the annual budget with a Nostradamus hat, as the other managers wanted, and “adjust” figures so that they would “please” higher management. For me it was simple and clear: PDCA didn’t stop at every turn!
Scott Dailey, C.P.M. says
“Manufacturing is a continuous, ongoing process and breaking it into arbitrary chunks based on a calendar is just plain silly.”
Tell that to the SEC.
Bill Waddell says
Scott,
Just because the SEC or the IRS require accounting to be performed in a particular way does not mean management accounting has to follow suit.
The notion that management accounting has to be in synch with financial accounting – or even tie back to it – strikes me as a weak excuse from many in the accounting profession for not taking responsibility for their obligation to contribute to the success of the business.
Dwayne says
And THIS is why Bill Waddell is one of my heroes!
Scott Dailey, C.P.M. says
Bill,
If you are insinuating that ‘financial accounting’ cannot (or should no) be tied back to ‘management accounting’, then you are off the mark. When and where there is a lack of transparency in financials, whether they are financial or managerial or for the IRS, you wind up with the type of financial tsunami that we are just coming to grips with.
I agree that accounting needs to step up and contribute to the success of an organization. But I don’t see the AICPA moving in this direction.
Bill Waddell says
Scott,
I beg to differ.
Do you cross check and balance your 1040 to your family budget and checkbook in order to assure that your tax returns are synchronized to the information you use to make the decisions in your life? When your family is contemplating a summer vacation or buying a new car, do you pull out last year’s 1040 for the information needed to make the decision? Would you suggest that a young couple planning to have children do their planning based on the Child Tax Credit worksheet? Of course not. You would use real numbers – which incidentally is the title of Jean Cunningham’s outstanding book on the subject.
If you told your spouse that your family budget and bank account balances could not be used for the day to day decisions in your life because you had a $378.56 reconciliation problem with last year’s 1040, she would have you committed to an asylum.
Who cares if the value stream contribution statements balance to GAAP data? The answer is no one outside of the accounting community. GAAP accounting is so fraught with allocations, assignments and accruals as to be useless for management decision making – and any manager who refuses to use real numbers unless and until they can be tied back to GAAP is foolish.
The numbers can be traced back to GAAP because they all stem from the same transactions – but the exercise of doing that reconciliation is pure waste. Refusing to provide management with practical numbers because one has not done, or does not know how to do that reconciliation is disingenuous.
The use of practical, meaningful information is hardly the cause of the “financial tsunami”. Quite the opposite is true. The financial tsunami occurred on Wall Street, in the banks and in the hallowed halls of Washington where GAAP reigns supreme. It had nothing whatsoever to do with the data managers used to run their companies.
The real drivers of the financial tsunami are rooted in the fact that accounting and real money – cash – have become so far afield from each other that it is impossible to tell what assets and companies are truly worth, and which companies are really sound and profitable and which ones are not. Had the whole country been operating more on a cash basis (the heart of lean accounting), and less on the basis of GAAP driven numbers games the tsunami never would have taken place.
There is a reason why privately held companies tend to outperform publicly traded ones – why the solid long term manufacturing success stories all come from the privately held sector. That reason is that those companies could care less about GAAP, and they are driven much more by cash and reality. They do not play the games with phony accounting and hokey accruals and allocations that get so many of the publicly traded companies in trouble.
The initial reaction from many in the accounting community was to rationalize keeping their GAAP numbers and denouncing lean accounting was the need to comply with Sarbanes-Oxley. That pathetic argument was blown away by the CFO’s of companies like Boeing and Parker-Hannifin who have embraced lean accounting and can argue more effectively than I ever can why tying management accounting to financial accounting is a fool’s errand. SOX is only relevant if financial management is dishonest, and has no bearing on managerial accounting.
You are right that the AICPA is not stepping up to the issue and, as a result, they are making themselves increasingly irrelevant. In too many companies accounting has set itself up as auditors of the rest of the organization first and foremost, and not as contributing members to the company’s success. Lean Accounting is enabling senior and operational managers to pass them by. They are learning that public accounting is a hindrance and that the cries from the public/financial accountants that their numbers are sacred are nothing but hot air. Senior managers are learning in increasing numbers that financial accounting will take care of itself if they run the business and make better decisions based on real numbers.
If accounting wants to reconcile management accounting with GAAP and their financial statements, they are welcome to it. But whether they choose to do so or not has nothing to do with whether management can and should use real numbers to run the business. A CEO would be wise to tell accounting the same thing your wife would tell you if you insited on reconciling the 1040 with the family checkbook – have at it if you want to waste your time on such a silly project, but in the meantime she is going to use the checkbook and the family budget to run the family regardless of what you and your reconciliation turn up.
Scott Dailey, C.P.M. says
“why the solid long term manufacturing success stories all come from the privately held sector”
ALL comes from the private sector? Really? Do you have data to support this? If so, then why do you reference Boeing and Parker Hannifin in your next paragraph? Last time I checked these were publicly trade firms. Laggards … no.
Leaders … yes. Long term successes …. yes.
Cash is king, yes, but don’t discount the obstacles that accounting/financial professionals face in a typical public company as they attempt to improve the business.
Bill Waddell says
Neither Boeing or Parker are what I would call long-term sucess stories. I cited them as examples of companies in which the accounting staff is providing management with lean accounting numbers without worrying much about whether those numbers tie to GAAP.
There are a few publicly traded firms that are successful over the long haul, but every one of them has some unique circumstance. If you know of a publicly traded manufacturer other than Toyota or Danaher or others with unusual circumstances, I would like to hear about them.
What exactly are these “obstacles” the financial professionals face in the public companies that prevent them from improving the business?
Scott Dailey, C.P.M. says
Private sector firms will never win the long-term race, in terms of market share performance, because they do not have access to the public capital markets, thus will never reach critical mass to compete in the BRIC economies. In my mind the only measure of long term success is market share % … as it measures how well you compete.
Obstacles … let’s see, SOX is the primary one that I run into. We spend a gigantic amount of time providing twenty-something auditors with reports that ‘prove’ that we are not hiding anything.