It's that time of year again for many people whose companies are on calendar fiscal years -- the dreaded "budget cycle." Next to filing personal income taxes, this may be the most stressful financial experience managers face all year. The problem is that many budgets are imposed from the top down; yet, once set, it's expected that the budgets will be owned and operated from the bottom up. I know, because I've been there and done that -- on both sides. The best way to avoid unreasonable budgets is to take a proactive approach -- anticipating what top management is going to challenge and managing the process to the best possible outcome. First, a warning: The competition from imported goods and latent overcapacity somewhere in the industrial world often make price increases almost out of the question. This creates great pressure to use budgeted cost reduction to achieve the profit increases expected by Wall Street and shareholders. I can't adequately address this vexing issue in a one-page column, but here are some suggestions for analyzing expenses and managing the budget process for best results: 1. Understand the leverage points. Increasing budgeted sales and profit margins yields the biggest bang, but this is hard to control and dangerous to rely on. Purchased-material costs are usually the second-largest budget item, so look hard for ways to reduce costs through collaboration with suppliers. These cost savings drop directly to the bottom line. The next largest budget items to target are usually SG&A (selling, general, and administrative) expenses or "overhead" expenses in the cost-of-goods-sold. Direct labor typically falls about fifth or sixth on the list; although many people focus on it relentlessly, bigger savings usually can be achieved elsewhere. 2. Look for the biggest "fixed" dollars to reduce. Sort the budget items in descending order of annual dollar value and then work on the top of the list first and hardest. Also, sort the items by whether they are "fixed" or "variable" in nature. Go after the fixed expenses, because these kill profits if there are market downturns or shortfalls in sales. Once committed to, fixed expenses are difficult or impossible to change. Compare how fixed expenses have changed as a percentage of net sales from prior years -- to determine where fixed costs are being added faster than sales growth can support. 3. Study variable expenses in terms of dollars per unit or percentage of sales. Variable expenses usually are not totally variable, but should be considered as if they were. This means analyzing them based on a percentage of net sales, then locking that percentage into the budget and measuring against it (instead of a fixed annual dollar amount). When sales and production go up or down, these expenses should move with them. 4. Use zero-based budgets for the small (and even some large) accounts. Review the accounts-payable ledger entries to see what was actually spent on the small accounts and itemize the needs. Don't simply include an "inflation factor." That budget line will be a sitting duck for the sharp pencil of the budget cutter if it is not defensible. Also, identify the discretionary spending accounts for special scrutiny. 5. Tie budgets to specific plans and actions. The way to create budgets intelligently is to work from the strategic plan down through the operating plans and link budget amounts to the goals and results to be achieved. Thus, if a given project, activity, or head count is critical to the success of the plan, the budgeted resources must be there -- and should be easier to defend than arbitrary percentage increases based on some assumed inflation factor. 6. Make a contingency plan before a crisis hits. Identify the contingency items that can and should be cut or postponed if topline sales (or profit margins) don't materialize. Better to identify them early than to succumb to the knee-jerk reaction of "cut everything." That is usually exactly the wrong thing to do. Those who do their homework will not only get the resources they need, but they are a lot less likely to get saddled with unrealistic budgets. It's better to be thorough, well prepared, and tough-minded once a year than to suffer 12 times thereafter -- at each monthly budget review. John Mariotti, a former manufacturing CEO, is president of The Enterprise Group, a consulting business. He lives in Knoxville. His e-mail address is [email protected].