This commercial reason is why you should never budget for an underspend
When I was a director of 7-Eleven we had a serious problem with theft and over-ordering.
Staff and customers would pounce on a poorly-managed store and take stock and cash at will. They did this:
A) because they could;
B) because it was left lying around; and
C) because 7-Eleven was the only company selling wines, spirits and beers that would hire an alcoholic to work unsupervised from 11pm to 7am!
We called the two areas shrinkage and bad merchandise. Shrinkage was theft and bad merchandise was over-ordered stock that passed its sell by date and had to be thrown away.
Controlling theft was an emotive subject for the board. Surely people were honest – especially our own staff and management?
Au contraire. We found that the majority of our shrinkage losses came from within.
In our management accounts we took the stock values and reported a gross margin. If the margin was less than the 30% we had budgeted, then bad merchandise and shrinkage were in play.
This was muddled and difficult to control. It had too many factors and smoke screens that were easy for local managers on the take to hide behind.
To fix this we introduced Shrinkage and Bad Merchandise as specific cost lines in the profit and loss accounts.
But here’s the rub. As a management team, we were now condoning theft as OK. The amount we expected to lose – that we had explicitly budgeted for – was probably 1.5% of our turnover. So that’s how much the store managers assumed it was OK for them to take.
Budgeting is a basic tool which ensures that all hell breaks loose if you don’t beat it. There is no way you can budget for an ‘underspend’ because, as the 7-Eleven showed, it just encourages unscrupulous managers to cheat the system.
An overspend should result in a visit to the Tower; an underspend a congratulatory visit to the Ritz. What say you to those who declare, “We told you about the underspends,” and then kept them? Sounds like those corrupt store managers to me!
At Moot we think that the treatment of these predictable outcomes should be spelt out in the agreement, as should the dispute resolution procedure.
And we think that when the annual budget is negotiated to avoid the relationship going to the wall the treatment of the previous year’s underspends needs absolute clarity and what will happen next years.
Please get in touch if we can help you in any of these negotiations.
