Time to review the Budgeting Process?

There is more and more consensus that the traditional methods of budgeting are increasingly unable to deliver value. They take too long, cost too much and are perpetually out of date. Evidence suggests that most organizations want to re-forecast (or update their targets) more frequently -- something that can be difficult and very time-consuming in many budgeting processes.

In a report published by Business Intelligence, entitled Reinventing Planning and Budgeting for the Adaptive Enterprise, Jeremy Hope, co-founder of the Beyond Budgeting Roundtable, is quoted as describing the fixed-performance contract (the budget being the prime example) as 'a management weapon of mass destruction'. Analysing what really happened at companies such as Enron, Tyco and WorldCom, he says: 'You can trace the problems back directly to aggressive targets that were linked to incentives that drive short-term actions.'

According to Simon Caulkin in an article in the Observer on 7 January 2007;

"Budgeting is now so completely taken for granted as the central pillar of management that managers are surprised to find it has not always existed. Dating from a time when manufacturers could pretty much sell what they made, it was a means for multi-divisional companies to co-ordinate production, allocate resources and costs, and make sure that people did what was required to achieve the schedule. For classic mass-production, command and control by the budget made sense. But in an age where everything is in oversupply, this model no longer works. It's no longer managers who decide what will sell, but customers. Logically, the budget, the hallmark of command and control, no longer works either."

Traditional budgeting emphasizes the reporting of actual results and the analysis of actual variances to the budget. It is intentionally backward looking and addresses only what happened, not why. As a result, traditional variance analysis offers no help in ensuring that the organization will repeat and enhance its successes or minimize its failures.

In traditional planning, budgeting is a discrete, annual event. This large-scale one-time planning exercise is sometimes complemented by a midyear financial reforecast of the current year to validate if the plan will be met. Few organizations, however, consistently maintain a rolling view of future performance. Instead, they are fixated on the near-term performance of the current year. This nearsightedness comes at the expense of long-term strategic goals and fundamental strategy execution.

A rolling forecast, built upon driver-based planning models, provides a continuous performance outlook beyond the current year, generally five to six quarters from the present quarter. Rolling forecasts typically include less financial statement line-item detail than traditional forecasts or budgets and emphasize operational drivers.

Driver-based budgeting, where non-financial drivers such as sales volumes and resource consumption rates are used to predict line item expenses, presents a way where a form of budgeting can be completed quicker and easier and re-forecasts can be more frequent. Instead of completing a detailed, bottom-up financial forecast (which closely resembles a traditional budget), the rolling forecast built from driver models focuses on the key operational drivers with the greatest impact on financial performance. This structure allows for rapid forecast cycles that provide the flexibility and timeliness necessary for more dynamic resource planning.

Because rolling forecasts are updated on a regular basis, if performance gaps appear, management can take action right away to mitigate expected shortfalls. Conversely, if performance surpasses expectations, resources can be freed up or reallocated to pursue other projects or opportunities. Many leading organizations are using rolling forecasts to improve their forecasting accuracy and operating agility while also dramatically streamlining their internal planning efforts.

Our experience is that guidance is essential and ongoing co-ordination and cooperation between different parts of the organisation is invaluable. Budgeting, planning or forecasting is a known and reliable way of achieving this if it doesn't become too bureaucratic and too time consuming. The secret is to co-ordinate and motivate performance towards common objectives in a way which enables resources to be used effectively and desired behaviour rewarded.

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