We all know the budget and we all hate it! So why do we continue to do it when it represents a static picture of the world seen at one moment in time? It’s not like we haven’t realized that the world is a lot more dynamic these days.

We’ll explore this topic in the next episode of FP&A Talks Series a collaboration between FP&A Trends Group and Anders Liu-Lindberg. In this episode, we speak with Knut Fahlén, a management consultant at Ekan Management and author of the book Dynamic Management Strategy.

Knut has been fighting the budget for years and is trying to make companies understand that they need to change their management model to cater for the dynamic reality that we face every day. But first, let’s stick to the budget…

Here’s what we think is wrong with it:

It’s one number with three distinctly different purposes being a…

• …target 
• …forecast
• …resource allocation

There must be a different way of doing this to cater for an ever-changing world, right?

Knut, you’ve spent most of your career working with FP&A, business controlling and written three books about business dynamics and two about the concept Beyond Budgeting. What are the most prevailing issues you find with companies continuing to do traditional budgeting?

There are at least 12 arguments against the traditional budget discussed in literature and they can be grouped into three major areas. 

1. First, the budget process is seldom strategically focused and is nothing more than a time-consuming number-crunching exercise about cutting costs. Even if it is necessary to discuss and coordinate financial numbers and business activities, these discussions do not have to follow a yearly plan with December 31 as a fictive deadline. This is, in fact, dangerous in today’s turbulent business environment. 
2. Second, the budget process is often very time-consuming and can be costly with little or no value added to the business. Today there are more efficient ways of working with resource allocation, forecasting and target setting to name a few good purposes with the budget. How this is performed today is not in line with the reality and need for dynamics and agility. 
3. Third, the process strengthens hierarchical command-and-control and generates a lot of dysfunctional behavior in the organization. Sandbagging, myopic behavior, manipulation of numbers around year-end are some well-known dysfunctionalities. 

What would you propose that they do instead?

What many companies are doing today is separating the budget process into three separate processes adopted to their business model and business environment. The resource allocation process should be based on strategic choices, “investments portfolios” or areas, and adopted to each company’s business rhythm. Not a yearly event where “the bank” is open once a year. 

The target setting process should work more with relative numbers and preferably in relation to others. If a target is designed this way you could do a good performance even if you did not meet the fixed target called the budget. The whole performance potential will also be un-locked, and not locked between a ceiling for revenue and a floor for cost. Cost must be considered good if it contributes to revenue. To monitor the cost/income relation could be one number defining your performance instead of if you reached the fixed negotiated budget number. 

The forecasting process should be more focused on real numbers on a rolling basis. By monitoring financial and non-financial numbers (cost and value drivers) on a rolling basis you can forecast and plan for a lot of scenarios. You will also get early warning signals by doing so instead of using self-biased forecasts saying that there will be no deviation from the budget at year-end. 

What I propose is to manage the business around three numbers instead of one fixed. The allocated number is your strategic choice, the target is where you want to end or continue to strive for, and the forecast is where you might end up. 

A concept like beyond budgeting has been pushed widely in the past decade, yet few companies have been truly successful in their implementation. Why do you think that is?

I have helped implementing parts of the beyond budgeting concept in a few companies and have met people or read stories from over 100 companies. Their failures sometimes come from fear of letting go of what they know and are familiar with. This fear usually comes from a new CFO, CEO, the Board or from auditors. 

I believe auditors must look more at the company’s management model instead of judging companies by the same yardstick, the budget. Think about it. How come that just about all companies around the planet have the same management model focusing on budgets and December 31 as a fictive deadline? The truth is that many of our most successful organizations in the modern world have innovated their management model to be dynamic and to gain competitive advantage. 

It’s clear that going beyond budgeting is complex and I have tried this too. We did this ten years ago and I was project lead on the implementation. In one way you can say we won the battle and implemented the process but lost the war of changing the way we operated and managed the company.

How do you think we can simplify things to make it easier for companies to succeed?

Work a lot with communication and visualization. My colleagues and I implemented a new resource allocation process and forecasting process at a pharma company recently and for some of the discussions, we even took away numbers and worked with bubble diagrams and trend diagrams. 

The discussions from this way of communicating became very open. Among the benefits were increased transparency and cooperation, heavily reduced time spent with tedious number crunching and planning. At the same time, marketing cost decreased but revenue remained, or trended, as before and they even had more fun in the whole organization. This last feedback – FUN – is what I am most proud of.  

If you were to suggest a concrete plan for how companies could become more dynamic in how they manage the company what would it look like?

There are ingredients, but no ready recipe. I would start to listen to others, read books and get inspiration. There are a lot written and the discussion is out there. Then, I would ask for help because there are so many pitfalls that you don’t have to experience. And I should design the model to 80 percent and then jump and learn. 

To follow a change management model is also necessary to succeed. I suggest you have an idea of 1) the vision, 2) what’s in it for individuals in the organization, 3) the knowledge about dos and don’ts, 4) the resources needed to work with the new way of managing and 5) a rough plan working with reasons and visions and the three processes from a holistic perspective. Thus, the concrete plan does not exist but the framework for implementing a dynamic management model exists. 

If there was just one thing people should take from this change in process and go implement immediately what should it be?

Don’t start with rolling forecast. Start with your strategic allocation and do it approximately right – not exactly wrong. Then monitor your numbers within your strategic areas – your portfolio. From trends or seasonal variation, you will be able to calculate forecasts that can be discussed and made to plans and activities based on other intelligence in the organization. This will make your organization more forward-looking instead of backward. However, not every organization can do this the easy way. You must design, adjust and find your own way. 

There’s no doubt that many companies have over complicated the change in management model to something more dynamic. And because they then failed to realize the expected benefits they very fast defaulted back to the budget or shied away from making changes altogether.

However, there are better ways of doing this and in this FP&A Talks we’ve presented you with some practical tips on changes you can start working on right away. We hope that this will get you started on becoming more dynamic and encourage FP&A to lead the way.