The Myth That Past Financial Performance Will Help You Move Forward
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How many of us have sat in rooms whilst a grumpy CEO or CFO uses the immortal lines: ‘Don’t talk to me about budget performance, tell me about this quarter’s performance compared to Prior Year’?
Clearly, said CEO/CFO may quickly decide they don’t like that answer and ask about budget again in the next breath, but it’s that quick thinking, lightning reflex action that separates the CEOs from us mere mortals, I guess.
I’ve spent too many days of my life sitting in budget-setting meetings and operational performance reviews where the refrain over and over again is how are we performing against last year’s numbers?
It never seems to matter whether last year was a good, bad or indifferent year, it has automatically and by default become the yardstick for this year’s performance.
It’s a rear-view mirror approach. The wretched rear-view mirror is all that the room seems to be
interested in. Looking backwards to define and often assess this year’s performance is absolute nonsense. Why? I would like to think that I do not need to explain, but the reality is that I do – otherwise it wouldn’t be the default approach that it clearly is.
The ‘use it or lose it’ syndrome
How often have you sat looking at your cost centre numbers as the end of another financial year draws nigh, thinking, ‘how do I make sure that I spend all of my budget’?
You see, we have all played the game, because we all know that if we under-spend against the budget, next year’s budget is likely to be adjusted down accordingly, and we might – might we not? – need that money next year, even if we didn’t quite use it all this year.
Indeed, if we think back, I think that’s how we justified that new fancy printer/expensive, off-site team-building event/new marketing campaign (delete as applicable) last year, wasn’t it?
Driving around any municipality anywhere in the world towards the end of the local authority’s financial year is a dangerous and frustrating business. Why? Because road departments everywhere in the world need to spend their maintenance budgets (which they have been hoarding literally in case of a rainy day) to ensure that they get at least the same amount of money next year.
You never see quite so many roadworks, pothole repairs and happy construction sub-contractors as you do in those last couple of weeks. Short story. Prior year budget was flawed because everyone used it before they lost it.
‘The past is a foreign country: they do things differently there.’
The past is the past. Last year was different to this year. Macroeconomic, political, environmental and social circumstances were different last year. I used to work in the cold beverage industry – for every one degree increase in the average temperature, you would expect to see a correlation in increased sales.
If you are heading into a new Ice Age, then is last year’s performance relevant? Micro business
changes will be there as well – new competitors, new products, new people to buy and so on.
Absolutely by definition, last year was last year. Its relevance to this year is real, but is not absolute and all conquering.
Yet the vast majority of us will have been there, as we take last year’s revenue and cost numbers, add a dollop of inflation (after all, the price that baked beans and toilet paper rose to last year is key to your business), and create a new number.
The finance and business teams then sit in endless meetings, where minutes are taken and hours are wasted, arguing to a standstill for a few days.
Those consensed, carefully worked numbers are then taken to the CEO and board, who bark out ‘Not enough improvement against Prior Year. Let’s take a cost haircut, and drive those sales teams harder ... Add 5% to the Prior EBITA line, and we are good to go. Good job, team. Love working with the best.’
Best said with a dodgy Michael Douglas growl from the bad old Wall Street days. Leaving you thinking, why did we bother?
To slightly misquote Franklin D Roosevelt, ‘To reach a port, you must sail – sail, not tie at anchor – sail, not drift’. Anchoring is not a business-specific or budgeting-specific challenge, but refers to a very real and well-researched psychological bias whereby one piece of information sticks in your mind and influences your interpretation of subsequent information.
You may, or may not, be aware of that bias, but it’s often there. A simple case in point is the ‘Black Friday’ sales phenomenon, occurring in November every year. Retailers carefully market that dream pair of jeans or perfect set of headphones in the weeks running up to ‘Black Friday’ at a full whack, probably escalated price, of $200.
The Black Friday sales show you can have this for $150 and you rush to purchase, having ‘saved’ $50. Actually, you have spent $150, but your mind was carefully anchored in the $200 reality and reference point. In the case of budgeting, getting stuck in the rut of Prior Year numbers is the anchor that is holding you back.
It’s a simple conditioning process; you have that as your natural reference point, so why look elsewhere? The rear-view mirror strikes again, because we are allowing the way the road unfolds behind us to determine how we feel about the road ahead of us.
So here we have the very root of the budgeting evil. Looking backwards, through the rear-view mirror, means that we base assumptions on our next financial cycle on a whole set of fallacious, erroneous and artificially manipulated numbers from last year.
Annual budget cycles are a tough, tricky process to get through. It’s much easier to base our thinking on what happened before, and as a consequence we allow that carelessness to fundamentally undermine the whole point of the exercise.
Frankly, the list of reasons why reference to last year is unhelpful is endless, but this distillation into three pivotal and key themes makes the point. You may not agree with them all, but I guess that ‘two out of three ain’t bad.’
This article is an edited extract from Ian Russell’s book, The Other End of the Telescope, available on Takealot.com and at all good bookstores nation-wide.