In most businesses, a budget is a static document in an active world. The budgeting process is actually backwards, disconnected from the reality of whether those budget targets can be met. In Execution, the first book I wrote with former Honeywell CEO Larry Bossidy, we said that operating plans typically are based on budgets that already exist. Instead, we argued that the budget should be the financial expression of the operating plan—not the other way around. In other words, the budget should be based on the realities of the market, the company's financial goals and its capabilities. This is common sense, but then common sense is very uncommon.
Creating an active, flexible document allows you to execute in good times as well as bad. To do that, you must build a budget that is based on the underlying plans from each business unit. In any budget, you have to know what the key items are—revenues, cost, capital, customers, niche, sales force, pricing, the value proposition—and then look at their interdependence. It doesn't matter whether it's top down or bottom up. In fact, it is both. Goal setting is done at the top and then you ask people at the lower levels what they see. Then go back to the top. Start at the top, go to the bottom, back to the top.
The linkage between various items of the budget often go through iterations because changing one item can spark changes in some other items. The iteration process requires intellectual honesty, rigor and transparency. It is done in the context of what managers see as key changes in the external environment and what internal capabilities need to be matched with those external changes. It is done through robust dialogue among managers.
In many companies, budgeting processes take as long as four months—by which time the environment will almost certainly have changed. There is a way to build a budget in three days, but only those with an appetite for robust and open dialogue should try it. The value of the iterative process is enhanced by an order of magnitude when the dialogue takes place simultaneously with all the relevant business leaders.
The three-day intensive session is total immersion. First, identify the budget lines with the rule that 20% of the budget lines account for 80% of the outcomes. All the business leaders go through the discussion of these lines, debate their interdependencies and change their budgets as they evaluate assumptions. They have a dialogue; they conclude a set of assumptions. They take a break for a couple of hours in order to go back and consider the impact on other items within the budget. They reconvene and see how the whole fits together. This way they can complete the process in three days, with five to six iterations and develop the final budget. A spreadsheet helps them see the whole picture and make only one or two changes.
Such dialogue and iteration makes the whole group of leaders totally aware of the interdependencies in their budget and thus the commitment is followed to execute the plan.
If you want a flexible budget, you must have flexible management. That is the only way that companies can have what it takes to change the resource allocation. Management in any industry needs to anticipate what's coming at least four quarters or eight quarters ahead. The purpose of anticipation is to see the volatility in order to be prepared for what kinds of action it will trigger—and to know how to turn the company quickly with budgets and operating plans that make sense.
Times are good for the metals industry. There is a bright light now. The industry is succeeding and that will allow the development of a new generation of leaders with a new mindset. Those who look down the road, who look forward, are prepared. Those who look retrospectively don't adjust.