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Budgeting Best Practices Just Got Better

What is missing from traditional “Best Practices” and how to change that

 I recently read an article by Barry Wilderman on SearchFinancialApplications.com (which is part of TechTarget.com) titled “Buying Software? Budgeting best practices come first”.  The entire article is available here. If you are not already a member you will need to register for this free site which encompasses many areas of technology and finance.

In this article the author focuses on the need to establish a budget process that borrows from best practices in this area of finance. The points given in the article are valuable and useful, however, there are a couple more critical areas that when observed and practiced will greatly complement this set of budgeting process best practices.

The most important aspect of the budget process is the usefulness and application of the budget with its analytics results in steering the company on its planned course. I’ve seen more than several organizations, some fairly large, where decisions were not supported by solid data; this data simply didn’t exist or was inaccurate or incomplete. Managements were often forced to use their experience, best estimates, intuition or perhaps no logic at all. Some of these decisions resulted in serious judgment errors with severe consequences to these companies.

We all read about companies who miss analysts’ estimates or come short of their own expectations. Some of the poor financial results are due to bad or inadequate planning, some due to unanticipated changes in the economy or customer demand, and some to historical poor analysis of actual company performance as compared with forecasted performance.

One of the most critical “Budgeting Best Practices” should include a complete and accurate forecasted Balance Sheet and Statement of Cash flows, without which management can’t make a fair assessment of the future financial health of the company.  Another is an analytics process that uses historical, current and budget data and displays the results in a manner allowing managers to quickly see and understand the data. I have already discussed these concepts several times on this blog in such entries as: Why you Must Forecast your Balance Sheet, Part 1 and Part 2, Why CFOs Need to Adopt Financial Analytics.

I agree with the points conveyed in the TechTarget article mentioned above but regardless of how well thought out and executed your budgeting process is you must make sure that these “Best Practices” and the actual software application you use are able to assist management in gaining insight into the future financial health of the company and in making the right decisions timely and with confidence.

Are you Challenged Managing your Annual Software License Fees Renewals?

How you can have Budget Maestro manage this task with ease and accuracy

All organizations rely on software products in their daily operations across all departments and business segments. Enterprise software ranges from ERP, accounting and finance applications to engineering, CAD, CAM, marketing and sales automation and also includes the software I am using to write this blog article.

Most software vendors structure their revenue streams to charge for an initial perpetual license fee based on the number of users, number of sites, options licensed, and some use the gross revenue of the business as a basis for the licensing fee.  Then, on an annual basis they charge their customers an annual maintenance fee, usually in the range of 10% to 20% of the original perpetual license cost.  Software licensing sold using the SaaS (Software as a Service) model requires a subscription, usually billed annually in advance of the service period.

The perpetual license fees should be treated as a fixed asset with a certain life, usually 36 months which can be run through the dedicated Fixed Assets software.

What about annual renewal fees and subscription model expenses?

Here, again, one can use Budget Maestro to set up a special plan to track these expenses, amortize them over a 12 month period, and most importantly know exactly how much to charge the software licensing annual fee GL account in each period, while updating the prepaid license fees account.

I just set up a simple plan to test this idea and I’m happy to say that it works great.

Here’s how I did it:

I created a new plan and set the calendar to match my fiscal year calendar.  I set the number of years to the maximum allowed.  With the advanced version of Budget Maestro you can have up to 30 years, but even the standard version gives you enough years so you won’t have to set up another plan for quite some time.

I set up a handful of GL accounts useful (but not required) in Budget Maestro and linked them to account groups to help with proper reporting. The most important account here is the “Annual Software License Renewal” expense account which I linked to a Depreciation Account Group.  Then, I created an Asset Group (the only one needed in this plan).  I set up a Depreciation Method I named Software License Renewals, gave it a one year (12 months) life with a Straight Line amortization and linked it to the “Annual Software License Renewal” expense account.  This means that all new entries will be amortized over the next 12 months and each period will show a reduction of 1/12 of the prepaid annual amount for each asset.

Now, as software vendors submit invoices for the following year’s renewals, I enter new “Assets” in the Budget Maestro Capital Assets Module.  I have my default set up to automatically assign these “Assets” to the only Asset Group I have in this plan, as well as the only Depreciation Method.  All I have to do is enter a Name, a meaningful description, the cost (from the vendor’s invoice) and the “In Service” date which will determine in which periods this new pre-paid expense will be amortized.  Users of Budget Maestro will immediately recognize these simple steps I am describing here.

This becomes very useful when there are many software licenses that have recurring annual renewals, all at different dates during the year and at different (and varying from year to year) amounts.  Budget Maestro then perfectly allocates the prepaid amounts to the proper periods for every item in the plan.  With a simple report I can see exactly the amount I must charge to the Annual Software License Renewal account while reducing the pre-paid asset account and maintaining a correct account balance every period.

While this is the way I decided to do this, I don’t see a reason why you couldn’t incorporate this function into your regular Plan and Budget, however, with a standalone system, you do not have to reload the software renewal fee items each time a new annual budget is created.

Other long-lived, intangible assets (e.g., Patents) can be tracked in a similar fashion and provide the data needed in order to make the required entries into the actual company GL.

All of these activities can be performed in a standalone, dedicated fixed assets software solution.  However, to me, having already licensed Budget Maestro, I can get all the information I need from the Budget Maestro reports and achieve accuracy and completeness in all the accounting transactions derived from these software license renewal fees activities, as well as all other tangible and intangible assets.

Of course, this text is not meant to provide any accounting, tax or other professional advice, only an observation for another great use of Budget Maestro, using the already licensed product and the number of users already authorized to use the software.

Are you Comfortable with Your Existing Budget Process?

Why it may be worthwhile to rethink the budget process and look for changes

From time to time I realize that certain tasks I perform, mostly personal and some professional, are harder to do and take longer than they should. It is, however, comforting to know that these familiar tasks will get done, albeit not in the most efficient and cost effective way. My logic is that next time, before I have to start working on one of these tasks again, I will first try to find a better solution. This seldom happens, although I’ve gotten better at it over the years.

Several years ago I was visiting a client, a mid-market direct marketing company on an internal control audit engagement. I noticed that the finance group employed three full time budget analysts and a budget manager. These four people dedicated almost 100% of their time to the budget preparation, consolidation and periodic maintenance. Their data for input was received from many department managers representing business units, divisions and locations.

Several other persons in the finance group also participated in the budget process, mostly during the review and approval phases. The finance VP was the process owner and the entire organization used Excel spreadsheets to compile the budget.  There were hundreds of them, many linked together and miraculously consolidating everything into a set of worksheets that once printed and bound became the official corporate budget.

When I interviewed the Finance VP about his internal controls I asked him how comfortable he was with the budget process, its accuracy and amount of time and effort it took to complete it. His reply was: “I’m not sure how accurate it is; I know there are errors in formulas and links and it is very hard to update, but this is what we have and we know the process well. It was designed years ago and we don’t feel we have the capacity right now to completely troubleshoot these Excel workbooks, or change the process”.

Coming from a finance department person, I was not surprised with his answer. It often seems easier and simpler to work harder and longer instead of taking the initiative and changing the way we do things by replacing the tools we use and the processes we employ.

You often hear that costs of new IT systems, software and other tools are what prevent organizations from optimizing their processes, achieve higher efficiencies, etc., while at the same time, the reality is that not incurring these costs and putting off making the additional effort to design an improved process is often much more expensive (especially long term) than the cost of the proposed process change.

To use this budget process as an example, most finance managers know that using spreadsheets is not the right way, which is why there are specific software solutions designed to remove spreadsheets from the process. Yet they continue to do it the hard way, while their organizations do not get the benefit from using available new technology.

As often is the case, change must be instilled by management with vision and focus on company objectives. Lower level managers are less likely to initiate or suggest change, even though they may realize its ultimate benefits.

In our example here it should be the company CFO who must initiate this change as we see in several of the blog entries on this site. A good example is “Become your Company’s Chief Future Officer”.

As for me, personally, I would like to think that I am more motivated now than before to find better ways to perform some of my tasks, even though I realize I might step into new territory and perhaps encounter temporary difficulties. What I do know is that changes well planned are worth making.

Are you Ready for the New Revenue Recognition Rules?

The deadline may seem far away but in reality it’s right around the corner

A popular and hot topic these days is the newly issued revenue recognition rules, a result of a decade long effort by a collaboration of FASB and IASB.  These rules are being phased in in the near future and will affect a variety of business enterprises, primarily those who have contracts and special delivery arrangements with their customers.

Revenue recognition is an accounting topic familiar to many companies who are engaged in providing goods and services to their customers.  It deals with the rules on when to recognize revenue for various products shipped or delivered, or services provided, and in what amounts in each accounting period.  It requires deferring revenues when applicable and then recognizing them in future periods, following specific rules issued by FASB.

The new rules, issued in May of 2014, require companies to examine their customer contracts and determine for each sales invoice what amounts can be recognized in the period of delivery and what must be deferred to future periods.  These new rules will become effective for reporting as early as 2017 with tracking of revenue transactions as early as 2015 with an adoption method either full retrospective or modified retrospective.  Generally, it makes recognizing revenues, both for products and services under more conservative guidelines.

What this implies is that accounting for revenue must be done according to the revised rules, which makes companies affected by these rule changes dependent on their ERP or accounting software to help them manage these revenue recognition transactions.  In addition to the accounting and finance functions, the new revenue recognition rules will affect the legal department, tasked with creating, reviewing and interpreting customer contracts, sales, and IT.

As of this writing many ERP and accounting software vendors are working on implementing these new rules into their existing software.  Other, vertical market software vendors, will be offering revenue recognition software that will be interfaced with existing ERP software to provide the needed functionality and allow for both internal and external audit of revenue recognition.

Similar to actual accounting software, companies who implemented a dedicated planning, budgeting and Analysis solution are going to have to re-think the revenue recognition planning and budgeting process in a similar fashion to actual accounting in order to make their analysis meaningful.

This is particularly true for companies who use their planning, budgeting and analysis software as an extension of their actual accounting software.  A software application like Budget Maestro with Analytics Maestro by Centage Corporation, which is an extension of the actual accounting system into future periods allows its users to adapt any accounting change rules and match its core structure to the General Ledger of its linked accounting software.

Although it appears that there is plenty of time left to make the switch to the newly adopted revenue recognition rules, prudent accounting and finance managements realize that now is the time to start working towards implementing the changes, including acquiring additional IT tools and modifying existing systems in order to comply with these new rules.

Are you Employing Leading Indicators in your Budget?

How to make leading indicators work in your favor

By Alan Hart

In traditional budget preparation people look at past performance (revenue, expenses, etc.) and try to set a new budget based on these numbers and a set of reasonable goals, so the new budget usually scales from a previous year.  Use of drivers is limited and reliance on key performance indicators (KPIs) hardly exists.

By using past actual performance data, for example: sales, gross margin and operating expenses, many key KPIs can easily be measured and presented.  Examples might include revenue per employee, revenue per square foot of retail space, office expense per employee, utilities expense per square foot of building space and many more, only limited by your imagination.

These KPIs, while important in measuring actual results, only tell a story after the accounting books have been closed for the period (month, quarter, year), allowing them to be compared with prior periods’ KPI values and with budgeted data.  They are known as lagging indicators and represent the output they portray to measure.

Since reacting to this data is usually difficult and often contrasts with goals (i.e., trying to directly change these KPIs may not yield the desired results), there has to be a better, and more balanced approach in dealing with this challenge.

In contrast, leading indicators represent the input they measure and have an advantage of allowing organizations to influence actual results through the controlling of these indicators.

A company’s leading indicators can be compared to economic leading indicators.  These are indicators that change in advance of changes in the economy, for example: Durable Goods Orders is an economic leading indicator that provides insight into future revenues in the manufacturing industry.  Similarly, an organization’s set of leading indicators can provide management insight into future performance of the company.

Every organization can employ leading indicators in the course of charting its business.  If we stop and think about it for a moment, we can come up with examples in every imaginable type of enterprise.  Here are a few simple examples:

Software publisher:  Visitor traffic to the website, number of actual pages visited and number of submitted inquiry forms can become an important leading indicator of future revenue.

Call center with billing revenue:  Call abandonment rate, average time to resolve an incident; call center queue metrics, etc.

Manufacturing Companies:  Book to bill ratio, trailing 90-day bookings, productive labor-hours in an accounting period, etc.

Monitoring and influencing key leading indicators is a lot easier than doing the same with lagging indicators.

Now that we’ve seen the differences between leading and lagging indicators, it becomes logical to realize that using both types of indicators in combination will allow a company to affect the desired output through controlling the input, its leading indicators.  In other words, since it is generally easier to affect leading indicators and knowing the relationships between the lagging indicators (the output) and the leading indicators (the input), an organization can be more successful in achieving its goals through working with both sets of indicators.

The idea is to use known leading indicators in your industry or even your specific business (within an industry sector) and intelligently affect budget components used in putting together the company’s annual budget and periodic forecasts or re-forecasts.  With the right technology and a little know-how this can become a reality.

As seen on Centage’s Budgeting and Forecasting Experts Blog