For many businesses, traditional budgets are a waste of time. In fact, that's being kind. They are often worse than that.
“At a growing number of companies, budgets have ceased to be at all.”
CFO Magazine
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They lower performance. They waste time and they cause lost opportunities.
The solution may not be sophisticated real-time technology and power analytics. The solution may be radical simplification.
I've learnt the lesson. I was Finance Director for a number of Philips factories in Europe in the midst of a rising Euro, cheap Chinese competition and the emergence of Carbon trading trading (sound familiar?). It was a high change environment, and we were under enormous pressure from customers, regulators, costs, competitors and currency.
I learnt that traditional budgets are bad. Why?
The problem with traditional budgets
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They encourage the use of an outdated financial model (which doesn't clearly separate fixed and variable costs)
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They give far too much emphasis to immaterial items, meaning time is taken away from what's important
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They are very time consuming to make, update, argue-over and explain
Traditional budgets are linked to financials more concerned with tax returns and annual reports.
They don't model what really drives a business. Too much time is spent explaining why real results have deviated from the budget. Those explanations quickly become almost ridiculous: real results are restated to be "comparable" to the budget on the basis that this is what would have happened if only financial markets and competitors obeyed our budget assumptions.
An attempted solution: Rolling Forecasts
Some businesses try to fix the time waste of budgets with expensive software, which is great for vendors. Other businesses have tried different approaches, such as Rolling Forecasts.
Rolling forecasts admit that the world changes so let's generate a new budget every three months.
But what happens if senior management targets stay fixed to the annual, one-true-budget? Then everyone is trying to explain what happened against two different sets of numbers. One step forward, but two steps backwards.
Philips had a "Beyond Budgeting" phase where we introduced rolling forecasts, making the budget officially just another three month snapshot (as a warning of what was to come, it was given a special name: "The Annual Operating Plan" when it should just have been the October rolling forecast). We tried hard, but the organisation couldn't move "beyond" annual targets. The budget AOP was what we were bonused on. The rolling forecast didn't replace the budget, it just became another layer. Our monthly reporting was full of reconcilations to both the budget and to the latest forecast. The problem started at the very top: shareholders didn't want the board following new targets every three months.
What works: radical simplication
Then the penny dropped that rolling forecasts were giving more accurate forecasts but not helping improve business results. The cost of doing all the detailed bottom up input was not helping the business. We thought at the least the process gave lower units "buy-in" to the process, but they were extremely happy to be rid of it. The people at the coal face knew a waste of time when they saw it ... it was head-office that took so long to get the message.
So we scrapped it all. We went to a simple one page format which was based on business drivers (but kept or even increased the frequency). An eight week process became two weeks. Countless hours of management talent was liberated to improve the business.
Of course, if the simple model indicated a problem, we reserved the right to go back to a traditional, intensive review, by exception.
We went to contribution margin reporting, and enabled much, much faster decision making.
If you're operating in a dynamic environment (and that's Australia 2011 for most of us), I'd give serious consideration to a much more streamlined approach. At the very least, don't base budgets on a financial accounting model (the P&L). But I recommend aiming for radical simplification. If a huge, vertically integrated and complex listed business can do it, then for smaller firms it's a walk in the park.
Read more:
CFO Magazine Goodbye Budgets: Goodbye Budgets
