Budgeting Mistake Business CaseBudgeting Case SituationA promotional items company, Promo LED (name modified for confidentiality purposes), headquartered in the upper Midwest, has developed interior LED lighting signs for the retail market; the company’s innovative signs were sourced to a Chinese manufacturer while Promo LED focused on the marketing, logistics and distribution of its new product. After eight months of trials with two of the major retailers in the US, the sign was approved for sale in the shelf at two big retail chains. Promo LED worked with the retailers to forecast the expected demand for the roll out, and then they had to place purchase orders to their third party manufacturer in China. During the first quarter, Promo LED sales increased dramatically. It seemed like the program was a complete success, but by the second quarter of the program Promo LED ran out of cash—credit lines were maxed out, and the third party manufacturer in China was threatening to stop product shipments if payments were not made in time. The retailers began delaying new purchase orders to deplete their existing inventories. To make matters worse, Promo LED’s bank was demanding the company to liquidate all available inventories.
Problem in a Budgeting CasePromo LED’s problems were rooted in the forecasting stage of the project. The company underestimated their cash needs by failing to review budgets and then update budgeting assumptions as the project got closer to a full roll out. The situation became critical when the retailers slowed down their purchases to deplete their inventory. Most of Promo LED’s pipeline was full, and they still had orders for another three months; they had assumed four weeks lead time for inventory while the reality was that they were placing inventory orders with upfront cash commitments sixteen weeks in advance. On top of the inventory miscalculation, Promo LED did not have a robust business software to track inventory turns and implement inventory control systems. Promo LED had failed to budget for the expenses needed for marketing their product properly; further, it hadn’t accounted for the cost of finding a reliable sourcing partner in China. So even before the company rolled out a single sale, it was already using credit lines to support the additional salesmen they needed in order to interact with the two big retailers. Not only were the salesmen an unbudgeted expense, but they needed additional logistical and technical support, which meant more upfront expenses for Promo LED. The company had created a budget where marketing expenses were incurred at the same time the sales were taking place, thereby minimizing the cash requirements. The excitement surrounding the company’s growth opportunities lead Promo LED owners to focus most of their limited resources in the marketing and technical areas in order to secure the business with the two biggest retailers. By the time they got to the roll out, their budget was outdated by three months and the working capital assumptions had changed.
Solution of a Budgeting Mistakes CaseThe first step taken to understand the full extent of the problem was to map the business process from the sourcing to cash collection. This allowed us to meet everyone involved with the LED project and to evaluate the business tools used to manage the Promo LED business. Soon it became evident that Promo LED did not have good forecasting and variance evaluation processes; the financial and operational areas were not communicating properly, which translated into poor communications to external stakeholders including vendors, customers and the bank. After we evaluated the entire process and detected some of the management weaknesses, we went back to the original budgets and performed variance analysis for P&L (Profit & Loss) as well as the monthly balance sheet; this financial exercise allowed us to pin point the operational and financial root causes for the Promo LED problems.
Once we were able to find the root causes, we developed solutions and an execution plan to address the weaknesses found.
Create an action plan for root causes
Communicate plan and improve process flexibility
Business Improvement EvaluationDuring the twelve months following our recommendations, Promo LED reduced its inventory levels and improved the inventory turns to meet industry standards. The company worked out the cash flow issues by having a disciplined team approach to the budget process and through constant follow up on their Key Performance Indicators. The process helped them to create a closer and more cooperative business relationship with both the vendor in China and retail customers. At the end of twelve months, the bank debt was completely paid. |
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