The annual budget process has long been a source of contention in dealerships. Department heads and mid-level managers begrudge the amount of time they must spend working on the budget, while owners and general managers worry about a lack of confidence and precision in the numbers.

Such concerns and complaints are nothing new, but they have accelerated in recent years. In fact, some companies in technology and other fast-changing industries are abandoning the traditional annual budget for more agile techniques such as quarterly rolling forecasts.

There does not appear to be much momentum toward the idea of radically changing the budgeting process in automotive dealerships, however. With publicly owned dealer groups and outside investors playing a larger role in the industry, the structure and control that the annual budgeting process imposes is still valued greatly. In addition, manufacturers and lenders continue to monitor their relationships with dealers based on financial results that are driven through budgets.

Because the conventional annual budget is likely to be here for a while, now is a good time for dealers to revisit and re-evaluate their budgeting and forecasting processes. Here are some basics to consider.

Who Drives the Budget?

The question of who is responsible for generating the budget is one of the most fundamental issues to be faced. In most dealerships, the CFO drives the budgeting process, but it’s important that the budget be developed from the bottom up, not the top down. The CFO and other top-level executives can present initial guidance based on input from a variety of sources, but it is the department managers’ responsibility to develop budgets for the new car, used car, service, body shop, and parts departments.

Department budgets generally are presented with side-by-side comparisons of the actual results from the previous year, along with a comparison against industry norms. These industry standards are developed based on input from various sources including manufacturer projections, CPA firms specializing in dealerships, consultants, 20 groups, floor plan lenders, and other peer organizations.

Ultimately, however, all the industry benchmarks and outside input must be tempered with the judgment and understanding of current economic conditions, and the dealers’ particular circumstances. In addition to local economic conditions such as expected population growth, threatened job cutbacks, or major new local employers, dealers need to factor in anticipated developments related to the brand such as a particularly attractive new model, recall issues, or other events that could affect traffic and sales volume.

The final budget is a result of a series of revisions and feedback, but in the end, department heads must own their budgets recognizing that their input drove the final version.

In addition to responsibility for the budget, another common question that arises is how much time the annual budget process should take. Some groups do virtually no budgeting at all, so their time commitment is minimal. For others, however, it is not unusual for the CFO to devote several weeks or more to various drafts, edits, and revisions. Ultimately, the amount of time it takes depends on the level of detail that management requires.

What to Include in the Budget and Why

When developing department budgets, managers naturally must focus on the expenses they can actually control. For example, the body shop, parts, and service department managers have no control over rent or utilities, but they can control their own departmental wages as well as advertising, coupons, discounts, and certain other costs. In the new and used car departments, the three largest controllable expenses that always are budgeted are commissions, advertising, and floor plan interest expense.

The budget also should identify any additional resources that will be needed to achieve the targeted levels of performance. For example, if the parts department targets 10 percent growth, it might need more people and more inventory on hand. The budget must identify not just what will be done but also what will be needed in order to accomplish goals.

Informal discussions with CFOs over the past few months revealed another common feature of dealer budgets: Most focus on income statement items such as revenue and controllable expenses, but relatively few give adequate attention to balance sheet items. In addition to the common profit and loss (P&L) line items such as sales and controllable expenses, here are some of the critical balance sheet items that also should be addressed in departmental budgets:

• New and used car departments: Vehicle inventory (days’ supply, in both units and dollars), contracts in transit (days’ supply by type including traditional, lease, and secondary finance), and finance receivables (days’ supply)
• Body shop and service department: Parts and service receivables, warranty receivables, work in progress, and sublet work
• Parts department: Parts inventory (days’ supply), parts older than 12 months, and special order parts on hand

In addition to the individual controllable line item departments’ budgets, the final dealership budget also must incorporate fixed costs such as rent, insurance, utilities, and office salaries.

A Process, Not an Event

Although some dealers are moving toward six-month budgeting, the annual budget is still the industry norm. In either case, in order to be genuinely useful as a management tool, budgeting should be an ongoing process rather than a once- or twice-a-year event.

Budgets should be broken down into monthly periods, which are seasonally adjusted to reflect the traditional ebbs and flows of business throughout the course of the year. These monthly budget numbers are the basis for actual-to-budget comparisons, the essential step for turning the budget into a strategic working document rather than just a planning and reporting exercise.

The department managers and general manager should meet with the CFO or store general manager monthly to compare actual results to the budget projections and discuss actions that need to be taken to achieve desired results. The general manager or owners then will meet with all department managers quarterly to review results and agree on plans for the next three months.

Regardless of the specific scheduling, it is important that such review meetings always conclude with documented action plans. Department managers should be challenged to identify at least three things they will do differently for the next reporting period in order to improve results. They also should be able to identify successful initiatives from the previous period that they plan to continue or expand in the future.

Documenting these items is critical for accountability. These lists often are shared with other stores in a dealer group in order to capitalize on successful strategies.

Systems and Tools

Just about every dealer group these days relies on complex, customized software systems for managing inventory, credit, payroll, financial reporting, and various other specialized accounting functions. However, when it comes to budget preparation, the basic electronic spreadsheet program is still the most widely used approach. This is due to both the low cost of such software and the ability to customize spreadsheets to reflect specific items and approaches.

The widespread reliance on traditional spreadsheet software is beginning to change as a growing number of well-managed dealerships are implementing solutions that automate both budget preparation and the critical budget-to-actual comparisons. An effective solution makes it simple to update budgets on a regular basis. This can provide the dealer with some of the agility and quick response capabilities that are driving the trend toward rolling forecasts.

Ideally, the budgeting software also will integrate real-time reporting and monitoring capabilities, which will help make the budget an even more useful and effective management tool.

Making It Work

The ultimate measure of a budget’s effectiveness is use by department managers to manage their business. The most obvious and successful way to encourage this use is to link controllable budget items to managers’ compensation.

The compensation structure also should take balance sheet items into account. For example, in the case of a used car manager, for any unit older than 60 days, a non-reversible valuation reserve would be recorded against the department income upon which the manager’s compensation is based.

There is a downside to this, however. Advocates of rolling forecasts and other nontraditional approaches point out that when department managers know their compensation will be tied to their ability to “make their numbers,” they have natural incentive to prepare conservative, easy-to-attain budgets. The result is an unnecessarily contentious budgeting process as well as a final budget that results in less-than-ambitious performance goals.

The link between budget performance and compensation must be designed carefully to minimize this problem. For example, in addition to offering performance bonuses for meeting budget targets, the compensation package also should reflect other operating performance metrics as well as the department’s contribution to overall dealer profitability.

By fine-tuning the link between budgets and compensation, actively monitoring budget-to-actual performance, proactively challenging department managers to pinpoint improvement opportunities, and documenting and tracking their implementation, the budget can become much more than an annual challenge. Instead, it can become an integral part of the dealership culture and serve as an effective year-round management tool that improves performance and profitability.