previous year and all of the “low-hanging fruit” that
can be exploited. The almost certain result is a sales
goal that has a chance to be met only through a
combination of real stretch performance and a healthy
measure of luck.
As the rest of the plan is developed, that process is
duplicated with regard to gross margin, expense control,
inventory management and accounts receivable
collection. For every sector, a goal is established.
However, the stars would really need to align for the
goal to be attained.
Individually, the goals are difficult to achieve. Collectively, they represent a pathway to failure. In addition,
some goals may well be mutually exclusive. A serious
shortfall in performance against the plan is almost certain.
The ultimate problem is not a failure to perform
against the plan. It’s the fact that the plan itself was
flawed. Even worse, this year’s set of unattainable goals
will be replaced by another set next year, followed by
another and another and another—in perpetuity. The
company settles into a very systematic approach to
planning. Set unachievable goals. Miss them. Repeat
annually. That is a sure prescription for failure.
There is no inoculation against unsuccessful
stretch budgeting. However, one alternative approach
has proven effective in helping firms develop sensible
goals that result in sustained improvement. It is
commonly called “profit-first budgeting.”
Exhibit 1 on page 50 looks at the profit-based
budgeting process for a typical PEI member based on
the results of the latest Distributor Profitability Trends
Report from the Profit Planning Group. The “Current
Results” columns show that the firm generates
$7,000,000 in sales and operates on a gross margin of
29.0 percent of sales. It produces a pre-tax profit of
$140,000, or 2.0 percent of sales. Expenses are heavily
weighted toward payroll, which is 17. 5 percent of
sales, or 64. 8 percent of total expenses.
To generate these results, the firm had to invest
$2,600,000 in total assets. The result is a return on
assets (ROA) of 5. 4 percent. That performance is
adequate but well below the firm’s full profit potential.
The “Action Plan” section at the bottom of the
table reflects the sequence of planning steps, and the
“Planned Results” columns at the top indicate the
impact of the Action Plan.
The key to the success of the plan is to start with a
profit goal. That goal should be well thought out and
completely justifiable. If the profit goal is achievable,
then everything else in the plan will be achievable
For this firm, the plan calls for increasing ROA
from the current 5. 4 percent to 7. 4 percent, a gain
of 2.0 percent. Experience suggests that boosting
ROA between 1.0 and 2.0 points will require the
firm to stretch moderately but is still realistic.