Keep calm and allocate capital: Six process improvements

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Keep calm and allocate capital: Six process improvements

By Tim Koller with Zuzanna Kraszewska | McKinsey & Company | June 5, 2024

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Most large corporations have annual processes to allocate capital and other resources across business units and for strategic initiatives enterprise-wide. The typical practice is to begin with a strategy or “strategic refresh,” develop a long-term (three- to seven-year) financial plan, and lay out a highly detailed budget for the first year of the plan. Unfortunately, the processes are often both muddled and rigid; they typically take months to iterate, generate reams of distracting detail—and then fail to allow for sufficient flexibility to adjust resource allocation over the year. The result: a failure to align resources with strategy.

Every company faces unique challenges. Not all of the measures described here will be appropriate in every situation, and there’s no one-size-fits-all list of process improvements. However, the authors find that in most cases, senior leaders should do the following:

1. Identify each business unit’s role and the most important enterprise initiatives.  Every strategic refresh should address two fundamental questions: first, what is the role of each business in realizing company strategy (such as to accelerate growth, improve ROIC, or divest), and second, which specific initiatives are the highest priority for the company, within that business and across the enterprise. In the author’s experience, they have found that the sweet spot for companies is ten to 30 essential initiatives. 
2. Focus on a small number of key value drivers for the long-term financial plan.  To be effective, a long-term financial plan needs to be concise.  An enterprise runs on value drivers, not accounting items. An effective financial plan clearly lays out the most important value drivers for each business unit, surfacing the few key elements that are most important for profitable growth, return on capital, and other company imperatives.  While the number of line items should be kept to a minimum, the number of business units or product lines should be sufficiently granular to aid the allocation of resources based on the roles, objectives, and needs of each business unit. 
3. Ensure that resources are allocated to the most important priorities.  Be clear on targets and have the long-range financial plan highlight the specific resources that are allocated to the highest-priority initiatives, whether they are enterprise-wide or within a particular business unit, to make sure those targets are met. 
4. Base this year’s budget on the first year of the long-term financial plan.  While the year one budget should be more detailed than the long-term financial plan, the top-line revenues, profits, and cash flows for each unit should always match year one of the long-term plan. Two techniques are useful for making this happen. First, start building the budget based on the initial year of the financial plan, rather than on last year’s budget or current year’s results. Second, require that only the CEO and CFO have authority to approve deviations from the long-range plan.
5. Compress the time frame for the entire planning process.  Financial planning can be a never-ending story. Precise timelines will vary depending on the enterprise—which in turn depends on its industry. But to borrow from the old saying, nothing so concentrates the mind as 24 weeks to finish a strategic refresh, a long-term financial plan, and year one of next year’s budget. 
6. Build in year-round resource allocation.  To prepare for inevitable changes in the number of resources needed and available during the year, the authority for meaningful flexibility in resource allocation should belong only to senior leaders, at the enterprise level. An investment committee, including the CEO and CFO (and ideally only one to three additional voting members, with the CEO making the deciding call) should meet monthly to make important in-year investment decisions.  These monthly meetings should be for decisions, not for progress updates or general reviews.

2 key takeaways from the article

1. Most large corporations have annual processes to allocate capital and other resources across business units and for strategic initiatives enterprise-wide. Unfortunately, the processes are often both muddled and rigid. The result: a failure to align resources with strategy.
2. In most cases, senior leaders should do the following to create this alignment: as part of the strategy or strategic refresh, identify the role of each business in realizing the company’s strategy and the company’s ten to 30 most important initiatives; use a streamlined approach to develop the company’s long-term financial plan by employing a value driver model, with only a few line items for each individual business unit or product line; ensure that the long-term financial plan allocates resources to the company’s ten to 30 most important initiatives; match next year’s budget to the first year of the long-term financial plan; keep to a compact planning schedule; and design in-year flexibility, at a regular cadence, to allocate more (or less) resources to existing or new initiatives.

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Topics:  Strategy, Business Model, Processes, Financial Planning, Financial Resource Allocation, Strategy Implementation, CEOs, CFOs, Financial Teams