The budget process still requires a lot of time and effort, which risks creating an outdated financial picture before the year starts. This blog explores how much value should be placed on detailed budgets and examines the methods that can help streamline any budget team.

Preparing a traditional draft budget

Some managers close their laptops in summer for a couple of weeks, leaving the finance team to calculate next year's budget. Hopefully, before they leave, some key indicators have been provided, sales figures have been estimated, and top-down target KPIs have been dictated. Now the finance team have to pull it all together. Fundamentally, the aim is to achieve a higher return from increased sales while offsetting inflation and salary increases through reductions in overhead costs achieved through operational efficiency.

Alas, when department heads return to the office post-holiday, the first budget draft does not quite meet the expected profit levels or performance KPIs. This means it is time to quickly adjust cost assumptions, like FTEs and material costs, before cutting Capex to reduce depreciation. The remaining gap will be closed through some to-be-identified cost efficiencies. And as a last resort, we can assume that next year's sales will be driven higher through commercial initiatives.

Shortly before the submission date, finance will spend long evenings populating templates and creating presentations. These will detail cost and profit centres, company profit and loss (P&L) accounts, balance sheets and side ledgers, including all the numbers requested by divisional leaders, functional leaders or head office. In my work experience, I have come across budget periods like these, which has led me to look for a change in the approach.

Benefits and drawbacks of traditional budgets

This yearly exercise can appear tedious and frustrating, but it may not be worthless. On the positive side, it answers the human need for guidance on the future, and it applies to the typical 12-month business calendar year. It supports planning the company's finances and provides guidance for external stakeholders. While top-down targets help fix the direction of the plan, bottom-up budgeting creates ownership and accountability. 

The biggest drawback is creating the illusion of knowing the future, especially since the latter budget months are very far ahead when the budget is drawn up. On top of this, traditional budgeting lacks flexibility and cannot react to unforeseen changes, especially market changes. On the other hand, costs tend to stay in line with budget, even when sales trail behind, resulting in frustrated managers. Top-down targets do not allow middle management to feel ownership and can cause them to feel overruled.

Implementation of modern budgeting processes

Two alternatives to traditional budgeting are: 

• to abandon budgets and replace them with a rolling 12-month forecast; or
• to take budgets to a modern state by acting on mindset, processes and tools. 

A leading budget process considers its traditional organisation with emphasis placed on the measure most influenced by external factors: sales. The premise is simple - the enterprise's resources will be adjusted to offset future revenue deviations and ensure the budgeted bottom line is achieved. 

Let's figure out a budget process that recognises that sales achieved will fall within a specific range above or below the desired growth level. Then use this to calculate budget scenarios for costs and investments.

Implementing a modern budget process starts with agreement at the leadership level that scenario-based budgeting provides more value than a single budget. This concept is then cascaded down the management layers. There may still be resistance to change despite the frustration around the tediousness of the traditional process. 

The reason for resistance may be due to a lack of understanding of the new concept, perhaps perceiving it as an increased workload as a result of several budgets. It can be helpful to teach management that scenario-based budgeting can remove their fear of committing to one single version of deliverables. As the champion of modern budgeting, top management needs to provide clear support to finance to enable success. Efficient budget meetings between finance and all functions should result in agreed prioritisation of resources and eliminate sandbagging. The latter are traditionally used to compensate for revenue headwinds and deliver the budgeted result.

Calculating one budget scenario is already an extensive and complex exercise, considering the re-calculation of cost and profit centres, legal entities, business divisions, and other parties involved. Therefore, calculating scenario-based budgets to return a landing range of profitability will require powerful ERP and BI tools to process the quantity of data. Saving as much effort as possible on data entry is crucial so that finance staff can improve their work. They are then left to focus on agreeing with budget drivers, discussing with business leaders and configuring the budgeting system. They can leave the requested templates and ledgers to be completed by intelligent tools.

Disclaimer: These blogs represent the opinions and perceptions of the author solely and in no way commit his current or previous employers to his ideas.
 

The article was first published at Unit4Prevero.