5 Reasons why most budget cuts fail

In preparation for an upcoming recession, finance teams across the country are creating various scenarios and updating financial plans to help the organization figure out how to ride out or even grow in the uncertain times ahead. For many, that involves cost-cutting measures, including laying off employees and slashing discretionary spending.

When we look at the data, most companies are really bad at sustaining cost cuts. In 2005, McKinsey ran a study on the effectiveness of cost cuts. They learned that 90% of companies fail to sustain cost cuts over time. (1)

As companies prepare for the worst, leaders are counting on the organization to execute their updated financial plans. With all cost reductions, there's little room for error. A few wrong decisions could be the difference in months off of your runway.

So where do most companies go wrong, and how can you avoid making the same mistakes?

No one likes reducing costs. What makes things even harder is 1.) you are being asked to move quickly 2.) every employee in the company is reading headlines in the news about layoffs, inflation, and a looming recession; so in order to increase speed and reduce employee concern, you may find yourself in a position of working on budget cuts with a small task force. But there are major risks to cost-cutting in a bubble.

When decisions are made top-down without gathering input from the employees ultimately accountable for the cutting, you may end up with budget changes that work theoretically but are not realistic. You also run the risk of making a sensitive situation worse by making employees feel unheard and unvalued. This can have a more negative impact on the organization than you'd originally anticipated.

Bring key leaders into the loop early to collaborate on budget cuts. Then give them the opportunity to provide feedback, confirm your assumptions, and consider the trade-offs.

The Harvard Business Review suggests a technique called Overhead Value Analysis. (2)

"Overhead value analysis differs from traditional value analysis by making both the managers who incur the costs (suppliers) and those who benefit from them (receivers or demanders) responsible for identifying which costs to cut. Top management and the CEO make the final decisions, but they are guided by the combined judgment of the entire management team."

This model is geared toward larger companies that can afford to move a little slower. That article suggests that this can be accomplished in four months, but fast-moving startups and mid-market companies could also borrow from the cost-cutting technique.

By bringing more people into the conversation, you can identify the true impacts of certain budget cuts, and see the problem from different perspectives.

Present the situation as a shared problem, and empower them to propose areas where they can cut their own budget. They'll feel a sense of ownership of the plan and commitment to executing the change.

Cobbler makes organizing budget cuts easier by giving companies the ability to create bottoms-up forecasts. Departmental heads can also track success and make changes directly in one document for finance to approve.

*Tip: If you're managing this process on your own, try creating a template for each manager to fill out and consolidate them on your own.

The phrase "change management" often feels like it's reserved for large enterprise companies that are employing expensive consulting firms, but in reality, every time you make a change that impacts other people, you need to think through a strategy for how to enable those people. The bigger the change, the more enablement is needed.

Your work isn't done once you have an approved financial model. Many folks think that once the leadership team has agreed to a plan, they can make some initial cuts and go back to business as usual.

*Tip: Systems like Cobbler enable finance leaders to push budget changes to departmental managers and flag if any of their detailed plans also need to be updated. This is a helpful tool in navigating conversations with each business unit and helping them build out new tactical plans that will ensure that they will be able to deliver on your overall budget.

If no one is on the hook to make sure that these budget changes stick, then odds are they won't. Many companies look to finance to make sure that the organization executes on the changed financial plans, but if you want to hit your targets, you need accountability from the line of business as well.

When no clear owner is outlined, it's easy to assume that someone else will handle the issues.

This could be departmental heads or for more granular spending, a functional leader that reports to them.

Document the owners so it's clear to the organization who is responsible for what. (Cobbler makes this easy by allowing you to assign an owner to every single budget line.) Set clear expectations that they're responsible for executing on their spend target, and help them understand how to communicate if things start to go off plan.

When a person knows that they are on the hook, they're more likely to make sure that the plan is properly executed — and if something starts to go sideways, you'll know exactly who is responsible to help get it back on track.

Once you've made the budget changes and communicated them to the organization, you need to have a way to track whether or not they're working. Many organizations rely on static monthly budget variance analysis (BVA) reports that don't give them actionable insight into what's actually happening.

These reports make it hard to understand where issues are occurring and prevent you from taking corrective action in a timely manner.

Read the best practices for how to create effective budget variance commentary.

To stay on course, you need more frequent reporting. Creating rolling BVA reporting will help you regularly monitor how you're spending against your corporate forecast.

This could be something as simple as tracking actuals against the plan on a weekly basis. This can get to be a big workload to manage in Excel with the team.

Cobbler's automated BVA reporting helps show you not only where you are against your targets, but also how that compares to the previous period. Automated reporting allows users to log in at any time to see how they're spending, and because Cobbler has a real-time connection with headcount data, the majority of most of your business partners' spend will be available.

This type of budget reporting will help you understand if your budget cuts are having an impact and, if not, where you need to take corrective action.

The finance team never grows as quickly as the rest of the organization. When you're making budget cuts, G&A headcount is often the first to get pushed out.

It's likely that the finance team was already under-resourced, and now you have even more on your plate. The business needs your help adjusting the financial plans and rolling those changes out to the business.

As finance teams try to manage their time, they typically focus on the things that are urgent and important (i.e. delivering the new plan to the CEO) and struggle to keep up with the things that are important but less urgent (e.g. dealing with the change management to make sure that these financial plans become reality).

Spend a little bit of time upfront, to define the process and automate as much of the FP&A workflow as possible.

Systematizing your FP&A workflow, will save your team time, enable you to have real-time reporting, and get more people access to actionable data. Managing this workflow with email and Google Sheets is possible, but take a large commitment from the finance team. Consider using a system instead that can automate your workflow for budget cuts and financial reporting.

Cobbler gives companies a single place to view their updated budgets. Once your budget is set up in Cobbler, you can push unlimited versions to the organization and provide them with granular permissions. Our platform makes it easy for FP&A teams to automatically update departmental managers on budget changes and keep them in sync with real-time reporting and accountability.

When it comes to making budget cuts that stick, there are a lot of potential pitfalls, which is why so many of them fail. If you're in the midst of a cost-cutting exercise, now is the time to consider how to improve your processes and capabilities.

Cobbler can help set your organization up for success by equipping employees with collaborative budget plans and real-time insights. Schedule a demo to see how Cobbler can help.

Footnotes:
1. Suzanne P. Nimocks, Robert L. Rosiello, and Oliver Wright, "Managing overhead costs," mckinseyquarterly.com, May 2005.
2. John L. Neuman, "Make Overhead Cuts That Last," hbr.org, May 1975.
3. "Communication Checklist for Achieving Change Management", prosci.com/resources/articles/change-management-communication-checklist.