If you missed the first installment of this two-part article, click here to find Part One.
Throughout the pandemic, companies reacted with drastic cost-cutting measures and by taking advantage of government programs, such as the Paycheck Protection Program (PPP) and Families First Coronavirus Response Act (FFCRA). They increased investments in technology and automation, shifted supply chain closer to home and improved their supply chain visibility. When forecasting into 2021 and beyond, companies can no longer take a business-as-usual approach. Business leaders need to be agile, forward thinking and communicative with all aspects of their businesses. Companies should have an increased focus on budgeting – even when trying to predict the future may be extremely difficult.
Budgeting and Cost Structures
The first step is to understand where you are as a company and where you’re headed. Start with a clearly defined vision from leadership of what the company’s future looks like. The pandemic forced change on companies of all sizes. Have consumers’ buying behaviors (whether they are end users or your companies’ customers) changed substantially? How do we adapt to those changes in behavior? Companies should review their standards and make appropriate revisions in their approach to budgeting.
Next, think about your top line. What are your revenue sources, and how have they changed during the pandemic? Do you have a concentration among customers, and if so, what will you do if that concentration were to drastically shift or decline? If top line results are uncertain, consider flexible budgeting, which will help you shift your budgeting techniques based on volume or other metrics.
Next, take a look at your fixed expenses. You may not have much control over fixed expenses, but still start thinking about what your long-term fixed expenses will look like. Maybe you can restructure your long-term contracts. Think back to the high-level question we asked earlier – if you built your business today, what would it look like? What would those fixed expenses be? Start now to successfully shift some of those costs to the extent that you can.
After that, you will want to take a look at your variable expenses. These are expenses that will fluctuate based on a myriad of factors such as volume, staffing and markets. Think about this from the ground up. For example, imagine what the sales process will look like in the near-term and what your sales team needs to be successful. What expenses will you incur now that you may not have incurred prior to the pandemic? Employee safety will always remain at the forefront, and extensive cleaning and safety expenses may need to be incurred at levels higher than in prior periods.
Companies should also consider shortening their budget cycle. Amending your budget quarterly or monthly may be more appropriate than setting a budget once per year. It’s never too late to redefine your budget.
Contemplate broadening the categories in which you budget. Instead of budgeting for outside sales travel, for example, consider aggregating all sales and customer acquisition expenses together. This will allow your company to quickly pivot to changes in sales methods or reallocate funds as needed.
Flexible Budgeting
How can you budget if you don’t know how much cash you will have? While not a new concept, companies that faced rapid growth or decline during the pandemic may be at a loss for how to budget moving forward. Consider adopting a flexible budget. Flexible budgeting allows companies to incorporate abnormal uncertainties into their budgets. Flexible budgets can be volume-based, revenue based or can be derived from any metric or driver that works. Think outside the box in what is right for your company. Does it make sense to gradually increase costs as revenues increase; or are there triggering events that may prompt increased costs or investments?
Long-Term Investment Opportunities
If your business was fortunate enough to make it through with capital or opportunities for investment, use this chance to think about long-term changes and investments you can make. With remote working, social distancing and limitations placed on businesses, it may make sense to implement new systems and invest in cybersecurity. Do your workers have the tools and equipment they need to remain efficient working from home? Some companies may have experienced significant growth due to certain customer demands. If you anticipate these demands to continue, consider investing in those lines of business and securing those relationships long-term. As supply chains gain relief and return to predictable and reliable levels, it will be important to remain your customers’ preferred vendor, and an investment now may help secure that relationship. Another form of investment is in building reserves (or re-building reserves). As discussed, predicting the unpredictable inherently can’t be done, but what you can do is predict that something unpredictable will happen.
Other Considerations
Under U.S. GAAP, overhead should be allocated to inventory based on the “normal capacity of the production facilities” (ASC 330-10-30-3). The definition of normal capacity will vary for every business, industry and situation. Examples of abnormally low production level could include significantly reduced demand, labor and materials shortages and unplanned facility or equipment downtime. Abnormal overhead costs should be expensed as a period cost. Conversely, in periods of high production or increased demand, the per-unit value of fixed overhead may need to be decreased as to not value inventory above cost. Companies should understand the potential impacts to inventory valuation in their budgeting, costing and pricing decisions.
Many companies use standard costing for valuing inventory and as a driver of other metrics. Material, labor and overhead standards should be evaluated. Processes may have changed significantly during the pandemic as well. It may make sense for companies to use different cost centers or cost drivers when evaluating or applying standards. Companies will need to weigh additional or new costs that have arisen as a result of COVID-19 (for example, safety measures, social distancing costs, implementation of a second shift and more) that will continue into the future when setting standards. Should the new costs be allocated to inventory or expensed as a period cost?
Consult With Your Advisors and Embrace Change – Adapt or Die
Because of the amount of change and disruption brought on by the pandemic, companies have evolved. Your accountants, bankers, attorneys and other advisors are here to help during these times. Sikich is one of the country’s top 30 Certified Public Accounting firms and a top 10 value-added reseller of technology products. We offer complimentary services ranging from business succession planning, human capital management, audit and assurance, marketing, security and compliance, among others – we’re here to help you embrace your unique adaptation to today’s unpredictable world.
With change comes opportunity. As Yogi Berra said: “The future ain’t what it used to be,” so “when you come to a fork in the road, take it!”
About our authors
Allan Lyon
Allan Lyon, CMA, CPA, MSA, is a director providing audit, accounting services, consulting, and, among others, due diligence engagements related to merger and acquisition transactions and serves a variety of middle-market manufacturing and distributing clients. He works as a consultant with clients in the areas of assurance, operations, inventory management, internal controls, strategic planning and financing.
Sylesh Babu
Sylesh Babu, CPA, CFE, ACA, DipIFR, is a partner in the company’s audit and assurance practice. Sylesh has nearly 30 years of experience providing accounting and audit solutions, with extensive knowledge in addressing challenges facing clients in manufacturing & distribution, business and professional services industries such as engineering, law, staffing and IT consulting services. In his role, he offers financial statement audit, review and compilation services as well as agreed upon procedures, due diligence, forensic and consulting services to businesses.
