LONG-RANGE PLANNING.
Long-range planning is the process of setting
forth certain goals and objectives for the firm to achieve over a specific
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period of time. Having a written plan enables management to unite behind a single set of objectives and provides a benchmark against which their performance can be measured. Every firm should have a long-range plan, regardless of size that meets the strategic or personal objectives of the owners.
Managers of professional services firms are often so preoccupied with the state of their relationship with their current client base that they believe any sort of planning beyond the current quarter is meaningless and a waste of time. Often it is. However, smart managers acknowledge this paradox but still press forward in establishing goals for the firm.
Long-range plans (LRPs) may be developed for any period of time, normally for a minimum of 3 years, often 5, and sometimes 10 years. Obviously, the longer the term, the less reliable the plan will be, but any of these terms is useful in quantifying the goals of the senior leadership team. The key to the development of any plan is to quantify and document realistic targets for the firm, as well as the strategies the firm will employ to achieve its goals. By quantifying these goals and strategies in the form of projected financial statements, the firm will also quantify the order of magnitude of its cash requirements for working capital in future periods and thus can take action to secure that funding with as much lead time as possible with the best terms available.
Once developed, the LRP should be updated each year as the initial step in the development of the annual budget. At a minimum, a well-developed LRP
will include:
• Executive summary (outlining in narrative form the major issues facing the firm and its prospects for the future, the firm’s goals, and its strategies for achieving those goals)
• Projected income statements (The LRP should be formatted in a way
that maps exactly to the financial statements of the firm to facilitate reporting against the plan as well as provide a consistent foundation for historical trend analysis.)
• Projected balance sheets and cash f low statements
• Key metrics, such as:
—Gross margins percentage
—Revenue per employee
—Operating margin percentage
—Net income as a percentage of revenue
—Staff cost as a percentage of revenue
—Compound annual growth rate (CAGR) of revenue
—CAGR for operating expenses, operating margin, and net income
—Revenue conversion rate (change in revenue/change in operating
margin) for each year
—Current ratio
—Debt to equity ratio
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—Return on equity
—Return on assets
• Capital plan (outlining key capital needs required to support the plan, including the type and quantity of equipment needed and cost for new initiatives, as well as the long-range replacement plan for existing equipment) ANNUAL PLANNING/BUDGETING. Once the LRP has been developed and
approved, targets for the upcoming year’s budget will result and, most importantly, they will have been developed in the context of long-range targets for the firm. Without achievement of the LRP’s first-year targets, it is unlikely the firm will be able to achieve its long-term goals. But once those goals have been established at a high level, the firm can then prepare its detailed annual budget for the upcoming fiscal year.
Some firms prefer to avoid using the word budget because many managers assume that they can, and should, spend everything in their budget even though it may not be necessary, thus leading to higher expenses than absolutely needed. Instead, words such as annual plan, forecast, outlook, first update, or latest update may be used interchangeably to describe the firm’s financial plan or budget for the upcoming or current fiscal year. Which term to use is a matter of management’s personal preference, but they should recognize that most nonfinancial managers still will refer to the annual plan as their “budget,” no matter what the firm calls it officially. The remainder of this chapter refers to the detailed annual plan as the “budget.”
When establishing budgets to which line managers will be held responsible, it is critical that those managers participate actively in the development of their departments’ detailed plans. If they do not actively participate in the process, the numbers they are given may be referred to as “the CFO’s numbers,” and it is less likely that the manager will buy into the numbers and ensure that his or her costs are managed accordingly. Situations where budget numbers are given to managers as their plan are often referred to as
“top-down” budgeting. The best attribute of top-down budgeting is that the numbers for each department will add up to be consistent with the LRP for the firm. However, line managers are unlikely to buy into numbers they did not create, and, in many cases, those top-down plans will not ref lect the line manager ’s knowledge of exactly what it will take to run his or her team—
erring on the low side could endanger client relationships and the quality of work produced, while erring on the high side will result in unnecessarily high expenses.
“Bottoms up” budgeting is just the opposite of top-down budgeting. Line managers prepare budgets that they believe they need in order to achieve their objectives and then submit them to the finance department to consolidate. Without guidance from above, it is unlikely this first set of budgets will aggregate to numbers any where close to the LRP requirement for the firm. Once those initial drafts are submitted, it then may require an extraordinary amount of work to tailor them back to a level that the firm can
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afford, wasting valuable management time in the process as well as creating unnecessary ill will among stressed managers.
A practical solution for this situation is to take the best of both methods by providing managers with order of magnitude target numbers for their department that are based on the parameters set forth in the LRP and then let them develop their own detailed budgets using those targets as a guideline as to where their final numbers should come in. Targets can be as simple as two or three key numbers, including revenues from the clients for which they are responsible, total compensation costs, and other out-of-pocket costs. Having department heads or team leaders prepare their detailed budgets within those targets can provide them with a sense that their input is valued by senior management and, in the end, the firm normally ends up with a more feasible plan that will be supported by its key managers.
While setting targets, revenue should be broken down into its major components, including a revenue plan by client, average billing rates for each level of staff working on each client, total hours to be charged to each client, and overall staff utilization rate targets by staff level. When finalizing revenue targets, in general, it is better to develop realistic revenue estimates that are achievable except for certain major catastrophic events and not
“push” them in the target setting process. By doing so, the firm is more likely to build its expense plan at a level that will be sustainable if relatively conservative revenue estimates hold true. When revenue projections are
“pushed” to higher levels to motivate managers to improve overall performance, expenses are likely to be planned at a higher level and the firm will suffer if those more aggressive revenues fail to materialize.
In summary, a well-organized budgeting process will include many, if not all, of the following steps:
• Establish the firm’s objectives first in the LRP process.
• Quantify the annual budget for the firm as a whole based on the numbers set forth in the LRP—for both revenue and expenses. The LRP and
budget should be formatted in a way that maps exactly to the financial statements of the firm to facilitate monthly reporting against the plan as well as provide a consistent foundation for historical trend analysis.
• Break that budget down into departmental level targets that each manager can use to develop his or her own detailed budget. While setting those initial targets, be sure to allow sufficient funding at the “corporate” level to cover overruns from individual departments that may be necessary to finalize all budgets at the end of the process.
• Consolidate initial budget submissions from all departments to determine variances from original targets given as well as the overall plan for the firm in total. Determine, at a high level, how much needs to be cut from expenses (or added to revenue) to achieve LRP targets.
• CFO/senior financial management should conduct reviews of the first draft of the detailed departmental budgets to understand key issues and
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reasons they might not be able to live within the target they were given.
Finance then should provide department heads with specific guidance as to how much needs to be cut and offer suggestions as to the source of such changes (but be careful not to order certain cuts because that will undermine the main objective of this bottoms-up part of the overall process).