Monthly Archives: June 2016

Important Budgeting Tips

Managing the budget numbers can be simple, but managing a budget takes people, not spreadsheets. While budget numbers are simple, budget management isn’t. To make a budget work, you need to add real management:

  1. Understand that it’s about people: Successful budgeting depends on people management more than anything else. Every budgeted item must be “owned” by somebody, meaning that the owner has responsibility for spending, authority to spend, and the belief that the spending limit is realistic. People who don’t believe in a budget won’t try to implement it. People who don’t believe that it matters won’t worry about a budget either.
  2. Budget “ownership” is critical: To “own” a budget item is to have the authority to spend and responsibility for spending. Ideally a budget management system makes plan-vs.-actual results visible to a group of managers, so that there is peer pressure that rewards budgeting successes and penalizes budgeting failures.
  3. Budgets need to be realistic: Nobody really owns a budget item until they believe the budget amount is realistic. You can’t really commit to a budget you don’t believe in.
  4. It’s also about following up: Unless the people involved know that somebody will be tracking and following up, they won’t honor a budget. Publishing budget plan and actual results will make a world of difference. Rewards for budget success and penalties for budget failures can be as simple as peer group managers sharing results.

Your budget and milestones work together
As you develop your budget, keep in mind your business plan milestones. That’s where you set specific goals, dates, responsibilities, and budgets for your managers. It makes a plan concrete. Make sure your budget matches your milestones.

Ideally, every line in a budget is assigned to somebody who is responsible for managing that budget. In most cases you’ll have groups of budget areas assigned to specific people, and a budgeting process that emphasizes commitment and responsibility. You’ll also need to make sure that everybody involved knows that results will be followed up.

The ideal plan relates the budgets to the Milestones table. The Milestones table takes all the important activities included in a business plan and assigns them to specific managers, with specific dates and budgets. It also tracks completion of the milestones and actual results compared to planned results.

The right organization for mergers and acquisitions

Internal organization that manages a company’s M&A processes has always been a major contributor to the success of its deals. Today, as companies increasingly choose to manage their M&A processes internally, without the support of financial advisers,1it’s all the more important to have the right team in place. This team must not only be skilled at screening acquisition targets, conducting due diligence, and integrating acquired businesses but also have the size, structure, and credibility to influence the rest of the company.

Admittedly, most of the best practices for designing an M&A organization are well known. But, in our experience, many companies fail to put them into practice. M&A teams include members with unnecessary skills as often as they lack members with essential ones. Too little capacity is a common problem, but inflated teams frequently create issues as well. The effect on a company’s ability to capture value from its deals is notable. According to our 2015 survey, high-performing companies2are significantly more likely than low-performing ones to report that they have the necessary skills and capacity to support essential predeal activities. Moreover, nearly two-thirds of underperforming companies lack the capabilities to integrate their acquisitions

Most senior executives understand the importance of strategically shifting resources: according to McKinsey research, 83 percent identify it as the top management lever for spurring growth—more important than operational excellence or M&A. Yet a third of companies surveyed reallocate a measly 1 percent of their capital from year to year; the average is 8 percent.

This is a huge missed opportunity because the value-creation gap between dynamic and drowsy reallocators is staggering (exhibit). A company that actively reallocates delivers, on average, a 10 percent return to shareholders, versus 6 percent for a sluggish reallocator. Within 20 years, the dynamic reallocator will be worth twice as much as its less agile counterpart—a divide likely to increase as accelerating digital disruptions and growing geopolitical uncertainty boost the importance of nimble reallocation.

Boost earnings without improving returns

All the measures of a company’s performance, its earnings per share (EPS) may be the most visible. It’s quite literally the “bottom line” on a company’s income statement. It’s the number that business journalists focus on more often than any other, and it’s usually the first or second item in any company press release about quarterly or annual performance. It’s also often a key factor in executive compensation.

But for all the attention EPS receives, it is highly overrated as a barometer of value creation. In fact, over the past ten years, 36 percent of large companies with higher-than-average EPS under-performed on average total return to shareholders (TRS). And while it’s true that EPS growth and shareholder returns are strongly correlated, executives and naïve investors sometimes take that relationship too seriously. If improving EPS is good, they assume, then companies should increase it by any means possible.

The fallacy is believing that anything that improves EPS will have the same effect on value creation and TRS. On the contrary, the factors that most influence EPS—revenue growth, margin improvement, and share repurchases—actually affect value creation differently. Revenue growth, for example, can increase TRS as long as the organic investments or acquisitions behind it earn more than their cost of capital. Margin improvements, by cutting costs, for instance, can increase TRS as long as they don’t impede future growth by cutting essential investments in research and development or marketing.

For example, to improve EPS, managers at one company committed to an aggressive share-buyback program after several years of disappointing growth in net income. Five years later, managers had retired about a fifth of the company’s outstanding shares, increasing its EPS by more than 8 percent. Yet the company was merely retiring shares faster than net income was falling. Investors could see that the company’s underlying performance hadn’t changed, and the company’s share price dropped by 40 percent relative to the market index.

Share repurchases seldom have any lasting effect on TRS—and that often comes as a surprise to managers and investors alike. Given how often we hear executives advocate share repurchases because of their effect on EPS—and make the occasional argument for taking on debt to execute them—it is worth exploring the relationship between buybacks, EPS, and shareholder returns. We’ll begin by examining the empirical evidence and then look at the logic behind so many decisions to repurchase shares.