“I hate this time of year! Finance wants my numbers next week. I don’t know what our sales or production will be next year. I guess I’ll use this year’s numbers and adjust a bit. There’s got to be a better way.”
Sound familiar? The annual budget planning cycle is a necessary yet painful time for many manufacturers. Finance requires a budget for the next fiscal year and draws inputs from various contributors including Sales, Engineering, Research & Development, Operations, Human Resources and Marketing. The process is intended to yield a more accurate budget for which each department head will be held accountable for next year’s performance.
What would you do? If you’re like most department heads, you’ll under-forecast sales and overestimate production costs and resources required. This, in turn, puts the burden back on Finance and senior leadership to enforce reasonableness, creating multiple iterations of plan adjustments and justifications.
There IS a better way…
Sales and operations planning (S&OP) enables companies to eliminate this painful cycle. Instead of Finance governing an annual event, S&OP refreshes future projections with a defined cadence, typically monthly. For example, an S&OP planning horizon of 18 months allows planners to see a full 12-month forecast for next year six months prior to start of next fiscal year.
If you’re thinking, “So now we’re repeating the budget planning every month? That sounds like 12 times the work,” please keep reading.
Why a budget driven by S&OP is better
The essence of S&OP is collaboration. Cross-functional participation is mandatory, and senior leadership support is critical. Once you’ve established an effective and efficient S&OP process, the annual budget flows right out of S&OP.
Here are some of the key benefits of an S&OP-driven annual budget:
- Leverages continuous collaborative planning
- Increases cross-functional participation in developing budget
- Ensures participants are more informed and less apt to make rough guesses
- Incorporates both top-down and bottom-up forecasting
- Increases acceptance of company rather than Finance budget
- Pulls Finance into S&OP process and out of budget governance
- Improves budget accuracy
- Ensures budget feasibility via S&OP demand and supply reviews
Using the Budget
Once the budget is set for the new year, what’s next? The budget should serve as a comparison to better understand deviations. If actual sales results are lower than budget, why? If production costs differ from budget, why? What can we learn from these deviations to improve future plans?
Business agility requires quick realignment of plans and “what-if” scenario planning. A Finance-driven budget disconnected from other planning systems means that Finance does not have the right tools to quickly adjust to operations plan changes, calculate expected revenue and margins based on the new plan and use that information to create a pro forma P&L. A pro forma statement would immediately tell the team if the proposed operations plan can meet or beat revenue and margin targets and give them the comfort they need to approve the plan. Without the right tools, Finance has to go through a tedious, manual process to identify potential shortfalls in revenue and margin from the proposed operations plan.
S&OP should be a great “friend” to Finance. Yet, many financial leaders stick to a painful, inefficient annual budget process. It’s time to pull Finance into the S&OP process and let them say hello to their new friend.