November 2005.’’ Bureau of Economic Analysis.
22 December 2005.
Hillstrom, Northern Lights updated by Magee, ECDI
BUDGET SURPLUS
When a governmental entity has revenues from taxes, fees, and other impositions which exceed its budgeted outlays, it is said to have a budget surplus. When a business under-spends its budget but all else remains the same, i.e., sales are at projected levels, it is said to have ‘‘improved profits’’ rather than experienced a sur- plus. Both the phrases ‘‘budget surplus’’ and ‘‘budget deficit’’ are usually applied to public entities.
Surpluses are almost always the consequence of two interacting forces: on the one hand efforts to contain costs or spending have been successful; and, on the other hand, revenues (over which government rarely has any genuine control except by raising or cutting taxes) have exceeded expectations.
THE U.S. FEDERAL BUDGET
In the 40-year period from FY 1965 to FY 2005, the Federal Government experienced a budget surplus in only five fiscal years. The government had a modest
surplus of $3.2 billion in FY 1969. In fiscal years 1998 through 2001, the government had surpluses of $69.2,
$125.5, $236.2, and $128.2 billion respectively. In all other years of the 1965-2005 period, the government experienced deficits, reaching a record deficit of $412 billion in 2004 (and a projected deficit of $331 billion in FY 2005).
The government’s exceptional performance between FY 1998-2001 was due to a combination of deliberate cuts in expenditures, particularly in the defense sector, and a booming economy due to the expansion of the Internet. The terrorist attack of 9/11 and an already softening economy changed the economic landscape.
A recession began in FY 2002.
THE U.S. HOUSEHOLD BUDGET
Although households rarely operate on a formal budget, the Bureau of Economic Analysis (BEA), an agency of the U.S.
Department of Commerce, calculates the ‘‘surplus’’ or
‘‘deficit’’ experienced by U.S. individuals and households as part of its National Income and Product Accounts.
National Income and Product Account (NIPA) data are used to build Gross Domestic Product estimates. BEA collects data on total and disposable income and total out- lays. Disposable income less outlays produces savings. The savings rate (savings divided by disposable income) is pos- itive to indicate a surplus and negative when households, collectively, experience a deficit.
In fiscal years 1992 through 2004, according to data available from BEA, U.S. households had a positive sav- ings rate but with a steadily declining trend. The savings rate was 7.5 percent of disposable income in FY 1992 but had declined to a 1.6 percent rate by FY 2004. Negative savings rates began to appear in FY 2005 in the ‘‘personal income’’ category; data for personal income tend always to be higher than the household data, suggesting that household saving rate has also turned negative; but in early 2006 no data had as yet been published for house- holds for 2005 by BEA.
B I B L I O G R A P H Y
Alesina, Alverto. ‘‘The Political Economy of the Budget Surplus in the U.S.’’National Bureau of Economic Research Working Paper Series.January 2000.
Bohn, Henning, and Robert P. Inman.Balanced Budget Rules and Public Deficits: Evidence from the U.S. States.April 1996.
Congressional Budget Office. ‘‘Historical Budget Data.’’The Budget and Economic Outlook: Fiscal Years 2006 to 2015.
25 January 2005.
Fearon, Craig. ‘‘The Budgeting Nightmare.’’CMA Management.
May 2000.
Reason, Tim. ‘‘Building Better Budgets.’’CFO.December 2000.
Budget Surplus
U.S. Department of Commerce. ‘‘Personal Income and Outlays:
November 2005.’’ Bureau of Economic Analysis.
22 December 2005.
Hillstrom, Northern Lights updated by Magee, ECDI
BUDGETS AND BUDGETING
In the broadest sense, a budget is an allocation of money for some purpose. The word once used to mean ‘‘pouch’’
or ‘‘purse’’; a budget therefore is ‘‘what’s in the pouch.’’
Budgeting as an activity ranges in extent from managing household finances on up to the preparation of the Budget of the United States, undertaken yearly by Congress; that document is rarely less than 1,000 pages in length. This article will focus principally on ‘‘formal budgeting’’ as practiced in corporations, sometimes called the ‘‘budget process.’’
Budgeting has always been part of the activities of any business organization of any size, but formal budgeting in its present form, using modern budgeting disciplines, emerged in the 1950s as the numerical underpinning of corporate planning. Modern corporate planning owes much to operations research and systems theory. A pioneer in that field, Russell L. Ackoff, worked closely with General Electric, Anheuser-Busch, and other major corpo- rations. His first book on the subject, the first of four, A Concept of Corporate Planning,had a major impact.
Modern formal budgets not only limit expenditures;
they also predict income, profits, and returns on invest- ment a year ahead. They have evolved into tools of control and are also used as a means of determining such rewards as profit-sharing and bonuses. Unless the budget- ary process is managed with extreme skill and care, the very virtues of budgeting can turn into negatives—and have, of late, emerged into a movement actively working to change this process.
BUDGETING AS A PROCESS
In large corporations, budgeting is a collective process in which operating units prepare their plans in conformity with corporate goals published by top management. Each unit plan is intended to contribute to the achievement of the corporate goals. Unit managers prepare projections of sales, operating costs, overhead costs, and capital require- ments. They calculate operating profits and returns on the investment they intend to use. The budget itself is the projection of these values for the next calendar or fiscal year. As part of this process, each unit presents its plans
and budget to a reviewing upper management panel and may, thereafter, make whatever changes result from instructions from or negotiations with the higher level.
Texts presenting, documenting, and defending the rationales underlying the numbers are usually part of the planning document. Approved budgets then become the road-map for operations in the coming year. Ideally monthly or quarterly budget reviews track performance against the budget. As part of such reviews, changes to the budget may be approved. At year-end managers are judged by their performance against the budget.
While budgets are developed bottom up, managers must strive to meet top-down corporate goals (e.g.,
‘‘Annual growth in after-tax profits of 39 percent.’’).
Because performance is measured based on meeting or exceeding positive projections (of sales, returns, and prof- its) and meeting or coming in below negative projections (fixed and variable costs and capital expenditures) man- agers have strong incentives for projecting the lowest possible ‘‘positive’’ and the highest possible ‘‘negative’’
results. The more successful they are in understating sales and profits and overestimating costs, the higher the like- lihood of ‘‘meeting the budget.’’ Top management’s incentives, by contrast, are to do the opposite.
Therefore the budgeting process is inherently marked by potential conflict.
Such difficulties can be, and usually are, mitigated by rational policies, good will on both sides, and straight forward implementation. Projections should be as realis- tic and quantifiable as possible. If projections are out of line with historical patterns, up or down, management must question the planning. Thus, for instance, a sharply rising projection of costs must have some real-world justification. Overly ambitious revenue projections must also be questioned. Conversely, managers must resist pressures sharply to raise revenue targets unless tangible changes in the market or compensating raises in sales expenditures are present. If the negotiating levels are honest and realistic, the right projections will result.
Ideally, operating units should not be measured on activ- ities over which they lack full control. An operation which does not operate its own debt collection, for example, should not be measured on how rapidly invoi- ces are collected. Since budgets are often at least 50 percent guess-work, formal budgetary review at reason- able intervals and realistic adjustments based on actual events must be part of a well-functioning process. All too often, the spring budgeting event is rapidly forgotten.
BENEFITS AND COSTS
The single-most potential benefit of formal budgeting lies in ensuring that responsible managers take time each year (and then at fixed intervals throughout the year) in Budgets and Budgeting
thinking about their operation by looking at all of its aspects. Budgeting creates a comprehensive picture of the future and makes both opportunities and barriers conscious.
This foreknowledge then helps guide day-to-day activities.
The chief cost of the budget process is time. In some corporations the process takes on a life of its own and becomes a convoluted exercise of excessive complexity which, moreover, prevents unit managers from doing any thinking: their time is consumed in efforts to comply with a vast array of requirements dictated from above.
Much of the negative attitude that has developed con- cerning this activity has its roots in unnecessary bureau- cratic impositions on the one hand and unreliability because of rapid change a few months out.
TYPES OF BUDGETS
The two dominant forms of budgeting are traditional and zero-based. Business planning is usually a combination of the two. Traditional budgeting is based on a review of historical performance and then the projection of such findings to the future with modifications. If inflation is high, for instance, cost trends of the last several years are projected forward but with adjustments both for inflation and for projected growth or decline in business activity.
Historical sales patterns, using established trends in sales growth, are projected; new sales from planned new prod- uct introductions are then added.Zero-basedbudgeting is the creation of a completely new budget from the ground up—as if no history existed. When using this method, the operation must justify and document every item of expen- diture and income anew. Brand-new operations will utilize zero-based methods.
In government planning, but only very rarely in business, performancebudgeting is used as a third alter- native. Under this method, the budget is fixed at the outset. The planning activity is to determine exactly what activities will be carried out using the allocated funds.
Performance budgeting is sometimes used in the corpo- rate setting when the advertising budget is arbitrarily set as such-and-such a percent to projected sales. The adver- tising function then uses performance budgeting to allo- cate the budget to various products and media.
CRITIQUES OF THE PROCESS
As early as 1992, the famous guru of management, Peter Drucker, wrote inThe Wall Street Journal:‘‘Uncertainty—
in the economy, society, politics—has become so great as to render futile, if not counterproductive, the kind of planning most companies still practice: forecasting based on probabilities.’’
Uncertainty has, if anything, grown since 1992 with the expansion of the Internet, the reality of terrorism, pressures on hydrocarbon fuels, the threat of global
warming, and worldwide epidemics. In addition to uncertainty, formal budgeting has also come under fire for impeding trust and empowerment, two new concepts in the evolving corporate culture, as well as for stifling innovation. As David Marginson and Stuart Ogden recently wrote inFinancial Management (UK),‘‘Budgets have long had a bad press, but they have attracted even more flak recently for being at best inappropriate to modern business practice and at worst potentially harmful . . . . The Beyond Budgeting Round Table (BBRT) has been one of their most vociferous critics. It argues, for example, that the necessary conditions of trust and empowerment in today’s organizations are not pos- sible with budgets still in place, because the entire system perpetuates central command and control.’’ Innovation is vital for economic survival. But ‘‘budgeting stifles trust and empowerment, according to its critics, which in turn stifles innovation.’’
The BBRT is an element of The Player Group, a management advisory firm; the Round Table has 29 major corporate members. On its homepage, BBRT advocates a set of principles which include, among others, continuous planning and controls (rather than an annual budget process), resource allocation as needed (rather than based on annual allocations and plans), high performance standards (rather than detailed rules and budgets), and freedom of action by small front-line teams (rather than direct control of operations from the center).
The high costs of the budget process and its poor adaptability to stock market perceptions is another force working to bring about change in the budgetary process as it has been practiced over the last 50 years or so. An article in The Practical Accountant put the matter as follows, citing Herman Heyns of Accenture/Cranfield School of Management: ‘‘[T]the budget process is obsolete given today’s economy, resulting in documents that are time- consuming to produce, of little predictive value, subject to gamesmanship and, quite frankly, out of date by the time they’re implemented.’’ Among the new approaches advo- cated by Heyns is the rolling budget. Under a rolling budget, performance of the operation over the last 12 months is evaluated on an on-going basis; projections for the next three months are generated every month.
Budgeting appears to be on the cusp of a change.
How long it will take to transform itself is difficult to predict. In a new book titled Beyond Budgeting, Jeremy Hope and Robert Fraser start off by sketching the ambiv- alence felt by top and middle management toward for- mal, traditional budgeting. Then they go on: ‘‘Though this ambivalence toward budgeting has existed for deca- des, the balance of opinion has swung decidedly in favor of the ‘very dissatisfied.’ Even within the financial man- agement community, nine of ten have expressed their Budgets and Budgeting
dissatisfaction, finding the budgeting process too ‘unreli- able’ and ‘cumbersome.’’’
The changes, as they evolve, will impact large corpo- rations first and foremost. For the small business owner, budgeting in the traditional sense will continue to be a sensible, necessary, and valuable tool practiced, in essence, by examining current resources, eyeing the future, and making rational allocations for the immediate future.
S E E A L S OBusiness Planning
B I B L I O G R A P H Y
Ackoff, R. L.A Concept of Corporate Planning.Wiley- Interscience, 1969.
Drucker, Peter. ‘‘Planning for Uncertainty.’’Wall Street Journal.
22 July 1992.
Fearon, Craig. ‘‘The Budgeting Nightmare.’’CMA Management.
May 2000.
Hope, Jeremy, and Robin Fraser.Beyond Budgeting.Harvard Business School Press, 11 April 2003.
Marginson, David and Stuart Ogden. ‘‘Budgeting and Innovation: Do budgets stifle creativity?’’Financial Management (UK).April 2005.
Reason, Tim. ‘‘Building Better Budgets.’’CFO.December 2000.
‘‘Throwing Out the Annual Budget.’’The Practical Accountant.
February 2002.
Hillstrom, Northern Lights updated by Magee, ECDI
BUSINESS APPRAISERS
Appraisers are agents who establish the value of busi- nesses, personal property, intellectual property (such as patents, trademarks, and copyrights), and real estate through a process known as valuation or appraisal. The demand for valuation of business enterprises has increased in the last several years in many industry sectors for a variety of reasons, including the rise in corporate restructuring, rising incidences of litigation (such as divorce, in which value and possession of closely held businesses may be hotly contested), changing employee- compensation packages, continued purchases of existing businesses, and the proliferation of employee stock own- ership plans (ESOPs), which require annual appraisals of value. Indeed, the dramatic surge in popularity of ESOP plans accounts for a significant portion of the increase in appraisal/valuation activity across the American business landscape.
Problems in the Business Appraisal IndustryBeginning in the late 1990s but continuing still, the appraisal industry began a process of change and consolidation
driven primarily by changes in the real estate sector.
Steve Bergsman, writing in Valuation Insights &
Perspectives,provides a summary: ‘‘There was a time not so very long ago, at least as recent as the early 1990s, when the appraisal industry—residential and commer- cial—was reliant on the mortgage lending business. By the middle of the last decade, however, a number of crosscurrents began to buffet that type of work . . . com- petition from other appraisers and technology. First, competition caused pricing to flatten; even banks admit there have not been rate increases in a number of years.
Second, new technologies, particularly automated valua- tion models, appeared, and more and more data, i.e., historical records of home sales and multiple listing serv- ices, became widely available on the Internet.’’ As a consequence of these developments, real estate appraisal has become a much less profitable part of this business.
Survivors of the shake-out, however, have found new opportunities in business valuation and litigation.
Finding a Qualified Appraiser But while the business appraisal industry is in a state of transformation, consul- tants hasten to add that many qualified appraisers do exist—and can be of valuable service to small business owners who take the trouble to investigate the merits of various appraisers. Keys to finding a good appraiser include the following:
• Network—As one tax and estate-planning attorney toldInc.,‘‘Ask around, and then ask around some more. Talk to people in your geographical area, even if their businesses aren’t just like yours; talk to people with similar businesses, even if they’re not in your geographical area. Appraisal is a fraternity, and once you know who’s in the fraternity, who’s respected, you’ll know who to go to. And, very importantly, if the reason you’re looking for a valuation has anything to do with taxes, or is likely to somewhere down the line, find out who’s respected by the Internal Revenue Service—who do they use to do their valuation work?’’
• Look for experience and education—Appraisers with significant experience and a good educational
background (MBA or CPA) are far preferable to those who are limited in either area. Moreover, some analysts believe that the appraisal industry is moving towards increased specialization (office buildings, hotels, professional practices, retail outlets, etc.); if possible, find an appraiser who is familiar with your business area.
• Recognize that valuations vary from client to client.
Appraisals of business can vary significantly in terms of their cost, both in terms of time and money.
Learn about standard fees imposed on business that Business Appraisers
most resemble yours in terms of size, health, and situation. ‘‘The vicissitudes of most projects—the standard ESOP valuation being an exception—often make it impossible to charge on a flat-fee basis, or even give a responsible estimate of hourlies,’’ warned Nell Margolis inInc.
• Find a licensed appraiser—The relative ease with which people are able to secure certification in the appraisal business has drawn fire, but it does establish a ground floor of presumed competence.
S E E A L S OBuying An Existing Business; Selling A Business
B I B L I O G R A P H Y
Bergsman, Steve. ‘‘The Changing Composition of Your Overall Client Base.’’Valuation Insights & Perspectives.Winter 2003.
Mobley III, T. Alvin. ‘‘Defining and Allocating Going Concern Value Components.’’Appraisal Journal.October 1997.
Semanik, Michael K., and John H. Wade.The Complete Guide to Selling a Business.AMACOM, 1994.
Tuller, Lawrence W.Getting Out: A Step-by-Step Guide to Selling a Business or Professional Practice.Liberty Hall, 1990.
Yegge, Wilbur M.A Basic Guide to Buying and Selling a Company.Wiley, 1996.
Hillstrom, Northern Lights updated by Magee, ECDI
BUSINESS
ASSOCIATIONS
Business associations are membership organizations engaged in promoting the business interests of their mem- bers. These associations typically perform activities that would be unduly costly or time-consuming for an indi- vidual company to perform by itself, including lobbying, information gathering, research, and setting industry standards. Association spokespeople contend that by com- bining their voices under one banner, companies are able to establish a strong and unified presence and effectively protect their shared interests. Leading business associations in the United States include the U.S. Chambers of Commerce, the Better Business Bureau, the National Restaurant Association, the National Retail Federation, and the National Manufacturers Association, but there are tens of thousands more that operate at local, state, regional, and national levels all over America.
Large firms have long been active participants in business associations, using the organization to advance their goals in a wide range of areas, from regulatory issues to research to industry image improvement. But smaller
companies can benefit from association memberships as well, provided they find an organization that adequately reflects their priorities and needs, which may be dramat- ically different from those of big corporations. For exam- ple, a small business owner may value an association that provides education, peer contact, and networking oppor- tunities more than one that is focusing its resources on eliminating an OSHA regulation that pertains primarily to large companies.
Before entrepreneurs and small business owners begin shopping around for an association, they should first compile a chart of specific business and personal goals, as well as a list of talents that they have that would be welcomed by an association. ‘‘All too often,’’
explained Robert Davis in Black Enterprise, ‘‘contact- hungry entrepreneurs and professionals join networking organizations before investigating them thoroughly. Does this sound familiar? You hastily join an organization, only to discover later that it’s disorganized, poorly attended and moreover, doesn’t meet your needs.’’
In order to avoid such a scenario, small business own- ers should undertake a serious information-gathering effort before committing to an association. People considering an association should first request a brochure or information packet on the group that adequately covers its background, philosophy, structure, services, and affiliations, then request a meeting with an association representative or attend an organization meeting or event to get more detailed infor- mation. Current and former members of the association under consideration are also potentially valuable sources of information. ‘‘Ask them about the level of commitment needed for worthwhile membership,’’ said Davis. ‘‘Also ask them to compare the benefits they have received from this organization with benefits received from other groups.’’
Associations can be a positive force for a small busi- ness. Many join local or regional chambers of commerce as a means of providing health insurance to their employ- ees. But all associations are not created equal. Some are poorly organized, poorly attended, and offer little benefit to ambitious entrepreneurs. Moreover, some entrepre- neurs, already struggling to find time to attend to both business and family needs, are simply unable to invest the necessary time to make association membership worth- while for them or their company.
S E E A L S OChambers of Commerce
B I B L I O G R A P H Y
Bovet, Susan Fry. ‘‘Leading Companies Turn to Trade Associations for Lobbying.’’Public Relations Journal.
August-September 1994.
Davis, Robert. ‘‘Look Before You Leap.’’Black Enterprise.
September 1992.
Eby, Deborah. ‘‘Who Needs Associations?’’America’s Network.
1 December 1995.
Business Associations