Among the different subjects touched upon in a recent Business Finance interview with Flowserve CFO Mark Blinn, we thought that Blinn’s comments surrounding budgeting and forecasting may hold special interest for finance professionals. Here’s a short excerpt:

Steve Player: What role does the budget play in your operation? Do you see yourself moving to a rolling forecast?


Mark Blinn: The budget’s a commitment, a benchmark, an expectation that you talk from. And it becomes obsolete the day after it’s approved for purposes of the forecast. This is a very important point, because companies historically have managed to the budget. But a lot changes in most businesses three months after the budget’s complete, and if you’re managing to the budget, you’re managing to three months ago.

Our planning group puts the budget together, and they also do a rolling forecast. The key is communication. The forecast puts something down on paper for me, but the most important thing is that it encourages dialogue. It means that we know what’s going on, and we interact with the folks in operations till we understand it. I can’t tell you how many times I’ve gone on a site visit and learned something that made me realize that we needed to think about things differently. Because a forecast is just that; it’s a vision of the future. But the more you understand what drives the business, and the more you talk to people out there, the better the vision.

A CFO, as you know, allocates not only capital, but also resources — and that’s expense. You need to hold people accountable and have a business discussion on both sides of the benchmark. You may decide that you need to go ahead and invest in a particular area, so you might want to flex that budget. On the other hand, you may decide that you don’t need those resources; you may need to reprioritize.

So we are, absolutely, going to maintain a budget process, because that’s how compensation is set, and it gives you something to hold people accountable to. When we set our budgets, we set the traditional stakeholder metrics around operating income, controllable income, and certainly cash flow. But we also put in operational metrics — for example, on-time delivery, billed material atrophy — that help us to build a sustainable business.

SP: How do you keep people from negotiating low-budget targets?

Blinn: Well, that’s important. Our process is top-down and bottom-up. We set targets based on trends, and we hand those targets to the businesses. It’s important to understand what they’re based on, because if I send them a target that’s not even based anywhere in relevant fact, then all I do is cause frustration. So we set high-level targets, and they go through a bottom-up analysis and deliver against the targets.

Typically, the way in which we design it is that we try to set targets fairly aggressively on trends, and the businesses typically also set out guidance within their organization that’s fairly aggressive. The concept is that you build contingency as you roll it out. You stretch it, and then you bring it back and make it reasonable, and that’s where the negotiation occurs. But it’s negotiation after the targets are set, and it propagates all the way up through the organization. The individual sites negotiate with the region, which negotiates with the division lead, and so on all the way up.

But it’s always part of the budgeting process that everybody tries to low-ball you. They come in with, “You know, next year is going to be the worst.” And you have to understand enough to say, “No, I don’t think so.”

And you’ve always got to take a step back and look at your budgets and ask yourself, “Am I motivating the wrong things?” You can have the best intentions and still drive poor business decisions. I’ve seen it happen. A good example is a sales organization; if you compensate your salespeople on sales and not on margin, they can sell you right out of business. But if you compensate them on margin, then maybe they will make the wrong choice there, too. You really have to think through these things. The most important thing is that the budget should be a collective effort. Don’t make it like two tablets coming down from the mountain. Make it less of a negotiation and more of a conversation, which is what it should be.

Once we get the budget locked, it becomes somewhat irrelevant at that point in terms of how we think of our business going forward because, as I said, if it becomes the benchmark, then people manage to the budget. So what you need to do is to start managing against your rolling forecast.

In this industry, whatever you say you’re going to do is your bond, so there’s a reluctance to forecast anything other than what I can absolutely commit to. Which is great from a conservative standpoint, but you always want to make sure that you have a good view. So that’s why we take the rolling forecast and run it separately from the budget process. It’s a case of “Tell me what you think you’re going to do — and, by the way, tell me what can go good and what can go bad.” ###