🔒How to better control, manage business unknowns

Former Secretary of Defense Don Rumsfeld was famous for posing this supposition at a Defense Department briefing:

“There are known knowns. There are things we know that we know. There are known unknowns. That is to say, there are things that we now know we don’t know. But there are also unknown unknowns. There are things we do not know we don’t know.”

He was trying to make the point that many of the largest challenges our country has experienced have come from events that could not have been forecast. Many business owners have dealt with this same fact pattern. Rumsfeld’s advice, however, was not to stop planning, but to create flexibility and readiness for the unpredictable nature of the world.

The same holds true for business. While we cannot know what the future holds, we can still plan for the future.

Forecasts and budgets are the tools business’s use to plan for the future and allow them to deal with the unknown unknowns. The forecast is the financial representation of management’s best guess as to what results will look like. There are three key reasons the budget is so important.

1. Creating the budget forces management to think about the business.

While we may not be able to predict the future, managers will certainly have opinions on what is likely to happen and how to maximize profitability. The creation of the budget gets the creative juices flowing to figure out how you will handle the known knowns and unknowns.

Questions related to revenues and costs will need to be answered.

What will sales be and can we produce this with our current capacity? What will be the head count for next year, and how will the increase in benefit costs impact your bottom line?

There are many questions that need to be answered, and each answer is a commitment from management. They are agreeing to operate within the framework they create.

2. The budget becomes a powerful management tool.

The budget is the culmination of management’s assumptions and commitments and provides insight into what will happen if all these agreements come true.

Does it work? That is the big question everyone wants to know when the information is plugged in. If it doesn’t “work” as in not enough profit or cash flow, then management understands what the goal is to make it work.

This forecast tool can be used throughout the year as new ideas and opportunities come across management’s doorstep. They just need to create the assumptions, plug them in and see if it “works.”

Also, should a big unknown unknown like losing a major customer come to pass, the forecast will quickly help you to understand the impact this unwanted change will have on your business.

3. Increased communication and accountability throughout the business.

The budget is a very clear way to communicate what is expected of everyone in the company. What is the sales goal and labor-cost target? How much can be spent on overhead?

All these questions are answered by the forecast. The forecast provides limited freedom to lower-level management on what they can spend, thereby freeing up senior management from making routine decisions.

“It’s not in the budget” is a legitimate answer to a spending request but not the final word. The budget allows for flexibility in that it provides guidelines of total spending. If savings can be found, then new spending may be made.

I often hear management complain that they do not have the money to make a desired investment. How can this be? It’s because management has chosen to spend that money on other things. The forecast makes managers take responsibility for their choices.

Many companies choose to forgo the budget believing it is only produced to be thrown in the drawer. They are missing out on what is one of the most important management tools.

Roy Filkoff is a CPA and partner with Altman and Company LLC, a turnaround, restructuring and crisis-management services business.