Budget process: Financial health check or cause for headache?

In some corporate boardrooms, the stuffy term “budgeting” has given way to the catchphrase “performance management,” reflecting attempts to continuously capture information to gauge a company”™s performance to stated goals.

In corner offices of some small businesses, owners use more colorful phrases to describe the exasperating process of predicting income and revenue for the upcoming fiscal year.

No matter the size and sophistication of the company, the budgeting process provides an opportunity to assess recent results against goals, and make course corrections.

Companies pour significant resources into the budgeting process, in the form of high-salaried certified public accountants (CPAs) or expensive software platforms from vendors like Stamford-based OutlookSoft and its corporate parent SAP AG.

Rather than hiring a CPA, small companies often turn to the relatively inexpensive option of purchasing accounting software from companies like Intuit Inc., Microsoft Corp. and Sage Software that have extensive planning capabilities.

The proliferation of such software platforms at small businesses has helped bring additional rigor to budgeting processes, but groups like the Connecticut Society of CPAs argue a software program is no substitute for an astute accountant.

While there appear to be no structural changes on the horizon that will have a big impact on budgets for the fiscal 2008 year, such as changes in depreciation schedules several years ago that encouraged companies to reserve funding for new equipment, CPAs argue they can produce a professional budget that can save companies money regardless of the business climate.

“It”™s almost like doing a business physical,” said David Gibbs, a partner in the Norwalk accounting firm R.L. DePanfilis & Co. L.L.C. “It”™s a perfect opportunity for what I call a business-health checkup.”

Others have argued the budget process itself introduces unhealthy processes in organizations. In a 2001 Harvard Business Review article, management researcher and author Michael Jensen argued that the corporate budgeting is “a joke” when it comes to determining compensation.

Jensen theorized that managers intentionally set low revenue targets in order to maximize bonuses they receive for exceeding those targets. The manager whose unit is already having a great year has an incentive to push sales into the next year to inflate future bonuses. Ironically, the same goes for the manager who knows he or she has no shot of hitting a minimum goal.

The only fix, Jensen argued, is to reward people solely for their actual accomplishments, and not for their performance against a goal.

“It consumes a huge amount of executives”™ time, forcing them into endless rounds of dull meetings and tense negotiations,” Jensen wrote. “It encourages managers to lie and cheat, low-balling targets and inflating results, and it penalizes them for telling the truth. It turns business decisions into elaborate exercises in gaming. It sets colleague against colleague, creating distrust and ill will. And it distorts incentives, motivating people to act in ways that run counter to the best interests of their companies.”

The distortion that imperils relatively small companies is overestimating revenue.

“The two words that go hand in hand, that people always need to keep in mind, is to be conservatively realistic,” Gibbs said. “A lot of companies tend to look at the top line and think that is the most important aspect of trying to grow their business ”¦ Most small businesses should be concerned about what they can put in their pocket, rather than how big their business can be.”

Equally dangerous is underestimating costs, said Barbara Bel, a partner with Eisman, Zucker, Klein & Ruttenberg L.L.P. in White Plains, N.Y.

“No matter how carefully a business owner plans, there are going to be surprises,” said Bel, who is a past president of the Westchester County chapter of the New York Society of CPAs. “At midsize and larger companies, we tend to see more respect for budgeting. Smaller (business) owners who wear a lot of hats tend not to spend as much time on the process.”

In either case, small-business owners often make the mistake of entering a fiscal year without having secured a line of credit from a bank.

“Those are your buffers against bad times,” Gibbs said.