Just like preparing budgets, the
task of approving budgets requires greater attention in these uncertain times,
writes Adrian McKelvie.
While
a single case will be needed for most reporting systems, boards need to see a
best case and a worst case scenario at least in summary format in uncertain
times like now.
Without this, directors lack a crucial piece of information in determining the ongoing financial health of the organisation.
Few
organisations have a budget system capable of handling times as uncertain as
the present.
The
flow on effects of COVID-19 are almost impossible to predict. Even industries
that on the surface appear to be less effected than others, are impacted.
For
example, the combined forces of a recession, the stimulus package and
quantitative easing will impact on inflation, interest rates, housing and probably procurement approaches.
Now
more than ever, boards need to fully understand the key budget assumptions,
have confidence in the budget process and consider their forward-looking financial
reporting requirements.
A fundamental question for boards in rapidly changing
environments is:
How can boards steer the organisations future with only backward-looking financials?
An annual budget process just doesn’t provide the necessary
frequency or focus to provide directors what they need.
You cannot change the past, but you can influence the
future.
In the current climate
it is advised that boards only approve operating budgets (the profit and loss
statements, balance sheet and cashflow) if they:
- have confidence in the budgeting
process - are aware of the upside and downside
risks from the base case budget - they are comfortable with the key
assumptions in the budget.
Boards should allocate
some time at a meeting soon after the budget meeting to discuss or investigate
risk management issues identified in the worst-case scenario.
The board should ask for a paper to be prepared that
outlines the cost and benefits of a rolling forecast system being introduced. At
a minimum, the forecast period should
cover two financial years.
The
following questions are designed for board members to consider before approving
the budget.
1.
What does the result need to be to allow the
organisation to deliver on its strategic aims? This is a back calculated number
not the result of the budget.
2.
How does management expect the rapidly
changing economic environment to impact and what has been built into the budget
document?
3.
How much stretch is in the budget being
presented?
4. What are the key assumptions in this budget? If we assume the budget model design is solid, then assumptions drive the outcome.
5.
What are the outcomes from stress testing
the key assumptions in the budget? What is the impact of moving these
assumptions? For example, 1 per cent variance
in the enterprise bargaining agreement has $X impact.
6.
Which assumptions are key to maintaining an
acceptable cash position?
7.
Does the worst-case scenario give an unacceptable
result? If so, the directors will need to discuss the next steps for the
organisation’s risk management practices.
8.
Does the board have concerns regarding the
robustness of the budget process? If so, they need to put this to the CEO.
The above does not
include specific questions about any of the results but is about understanding whether
or not the organisation has the core financial strength to achieve its aims.
These questions enable
that by clarifying what the result needs to be then probing the presented
results to ensure that the basis of calculation is reasonable.
Adrian McKelvie is an experienced chief financial officer and principal at Virtual CFO Support.
Read also: Budgeting during a pandemic
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