Riding out the recession will require a level of frugality not imposed on many businesses. Finance directors can’t hope to curb the excess until they can regain control of discretionary spending, says Neil Robertson, Compleat Software’s CEO.
While the middle classes revel in their new-found frugality, so the Daily Telegraph recently claimed, welcoming the need to have a new respect for what is spent where, the recession is having a similar impact on affluent as well as struggling businesses. It is now considered not only inadvisable but obscene not to know where cash is being frittered away. As a result, businesses of all sizes, and across all sectors, are now determining how to curb a level of waste they know is no longer acceptable, reflecting the last 14 years of a boom market and ready credit.
Yet, regaining control over the corporate purse strings is easier said than done. So much responsibility and disseminated power has been entrusted to departmental heads over the years that the average financial director now has very little sight of how discretionary spend is being allocated. When they do get a handle on this, it is after the event, when it is too late. All they can do then is report on the situation, using the often patchy information they have to work with.
40% of budgets based on guesswork
The figures are sobering. Around 40% of the typical company’s expenditure is ‘discretionary’?all spending beyond the raw basics of premises rental, fundamental utilities and staff salaries. This includes marketing and IT investment, right down to stationery purchases (and it’s a rare business that doesn’t have an overstocked stationery cupboard on every floor).
And the harsh reality for many companies is that much of this spending happens without being reported properly, preventing financial managers from establishing more effective controls. This is reflected by the value of accruals within the monthly management reports, simply because the company cannot effectively process the paperwork in time.
When outsiders are brought in to drastically overhaul a company, to raise its chances of survival when it has fallen on difficult times, one of the first measures they will take will be to substantially cut?or even freeze?discretionary spending. What’s often surprising is how little difference, in a negative sense, this action makes to the business.
But this supposes that the financial director has the power to take these measures. In many cases, the first he or she will know of the business’s discretionary spending commitments will be when these are entered into the purchase ledger. This is bad enough when spending falls within budget, but when the parameters are exceeded, the risks grow exponentially.
The risks of over-extending
One company was left reeling when the IT director had forgotten a £700,000 commitment as it renewed a series of licence and maintenance arrangements, but had already committed the budget spend for that quarter. The first time this came to light was six weeks after the invoice was received in the following month’s management accounts. Worse, payment was already overdue. Coinciding with extensive over-spending in another department, the excess was absorbed only with great pain.
Although this presented an opportunity, going forward, to ensure this would never be able to happen again, the oversight shouldn’t have arisen in the first place. And, the chances are, the business was already over-extended for the months ahead. Bringing spending back in line with budgets, or being able to initiate cuts, might have taken another one to two years.
Indeed, even if you change the rules, can you really be sure that the business is able to comply with any new restrictions you might now need to impose? Typically, as long as the budget is left with the budget-holder, the money will be spent. Some departments will take the view that they have a responsibility to keep spending, to ensure they’re allocated the same budget next year.
Locking down spending
When times are tough, proactive intervention is needed. Financial directors need not only greater and timelier sight of what’s happening, but the ability to lock down budgets and prevent access to funds at short notice.
This means taking back control of procurement above a certain level, and requiring senior managerial sign-off for anything out of the ordinary. At a process level, it means enforcing formal purchase order requisitioning, as well as following through with approvals and receipts, and processing invoice approvals electronically. Only by tightening up procedures and demanding closer involvement can financial managers reassert their authority over practices that have been allowed, during the heady days of prosperity, to become overly lax.
Even where businesses continue to thrive, this is still good practise. Recessions swallow cash and, since no one can be sure just how far the tide will go out during the current crisis, when it might turn, and how long it might take to come back in, prudent financial chiefs need to assume and prepare for the worst-case scenario. Which means preserving cash wherever possible.
The good news is that, by investing a modest amount (say, £15,000 or less for a firm turning over £8-10 million) in an automated, web-based purchase-to-pay solution, businesses can resume control of their discretionary spending within as little as ten days, from which point excess spending can be stopped, and turned into cash in the bank. At a conservative level, this might be 10% of all spending, but ideally it will be much more than that.
The point is, the financial director and the board now have the information and the ability to take such actions. An automated, integrated purchase-to-pay system allows parameters to be redrawn centrally. It allows purchase orders to be processed within hours rather than days or weeks, and without incurring additional administrative costs. It ensures that spending plans are logged and accounted for at the earliest possible stage, with immediate visibility. If budget problems arise, early action can be taken. The guesswork, and reliance on hindsight, is removed.
To add to these savings, other improvements to procurement strategies can be developed, such as consolidating purchasing with smaller numbers of suppliers, allowing preferential deals to be struck. But the first step in all of this must be to resume control, and to have 360-degree visibility of?and the earliest possible insight into?planned spending.