Many companies are now announcing budget cuts and layoffs in response to the uncertain economic environment. Unfortunately, most companies lack the finance tools and strategic clarity needed to navigate such an environment well.
A typical reaction we are already seeing in the layoffs announced this year is to try to cut costs in line with revenue reduction. If revenue is off 20%, they seek to cut expenses by 20%. Payroll costs might make up 70% of total costs and a greater percentage of costs that the company can rapidly trim.
It’s common for executives to turn to layoffs as a necessary tactic to “live to fight another day.” They believe the “willingness to make tough decisions” is one of the burdens of being an executive. They delegate the task of determining who should be cut to department heads that often are not bought-in to this action. To be “fair” to them, some CEOs give all the executives an even share of the burden by asking for “across-the-board” cuts.
Viewing payroll simply as a cost is the first mistake. After all, companies hire employees for a reason: to support the activities that produce revenue and create value. Cutting employees cuts those activities and the ensuing chaos following a layoff impairs them further.
Another mistake is fixating on fiscal year periods. In a difficult economic environment, the goal is not to have a good year. When the market changes, the goal becomes understanding how the market has changed, how the company needs to change in response, and how resources need to be adjusted or redeployed to ensure the activities of the employees align with the actions needed to survive and thrive in the future.
How to Navigate a Decline in Revenue
The first step to take when revenue declines is to analyze the decline. Was it a decrease in price or volume? What has happened to supply and demand? If volume has declined, consider the real impact on market demand. Perhaps customers have decided to put off making this purchase, and there is pent-up, unsatisfied demand. What will happen to relieve this pent-up demand in the future? Maybe customers have found a lower-cost substitute for your product. What can you offer at a similar price point to meet this demand? Has there been a long-term reduction in demand for certain products or services?
After identifying the root causes of the impacts to your revenue drivers, you can start to form the strategy for dealing with the new environment. This is what the executive team really gets paid to do – aligning the activities of employees and the investment of capital with the objectives necessary to succeed in the long-term. Companies that try to rescue the current year plan are distracted from making the right long-term decisions.
Understanding the most important initiatives the company should accomplish in the short-term allows you to take much more effective actions than across-the-board layoffs. Some areas of the business may need more staff, some employees may need to be retrained and redeployed, and some departments may need to run an initiative to improve productivity and reduce costs.
Naturally, you may determine that some product lines will have a long-term reduction in volume and you should reduce staffing commensurate with the decline in transactions. In that circumstance, the best you can do is to try to execute the layoff well and support the remaining employees. The work you did to understand your revenue decline and how the business needed to adjust to it will pay off here.
The Finance Tool to Navigate Difficult Times
The most important financial tool for running the business is a good driver-based rolling forecast that looks out about five years and which is based on Beyond Budgeting principles. Leading the effort to create a good one is probably the most valuable thing your Finance team can do for you. This is far more important in times where the future is uncertain and results are changing quickly. In these circumstances, your Financial Planning & Analysis team is wasting their time and yours if they put together a variance analysis telling you which departments and line items are over or under the (now obsolete) budget you all spent months putting together. Reforecasting to December is not going to be much help either.
A good driver-based rolling forecast creates clarity around the drivers of both your revenue and your expenses. Further, it enables agility in a challenging market. Instead of having executives complain about “arbitrary cuts” to “their budget,” you can focus on a strategy for success and the actions required to carry it out. A good driver-based forecast generally comes from iterating several versions. Nonetheless, the thinking and discussion required to put the first version together will help you navigate the near-term crisis. Times of uncertainty lead to faster buy-in and engagement from the executive team for shifting from a static budget to a dynamic forecast process. As the adage goes: “never let a crisis go to waste.”
Corporations spend a large amount of time, focus, energy and resources producing financial statements for boards and shareholders, preparing budgets and variance reports to control how money is spent, and developing bonus plans to align variable compensation with the successful achievement of short-term targets. These short-term targets are often obtained through activities detrimental in the long-term. For example, pulling revenue forward or focusing only on deals that can be closed this quarter.
It takes a relatively small investment to build a far better navigation tool to allow the company to navigate rapidly changing environments with agility and to align resources with the critical activities that move the business forward. The more the driver-based forecast is used and improved, the more able the company will be to navigate challenging times without across-the-board layoffs.