Are Traditional Budgeting Models Still Relevant?
I recently came across an article by the American Management Association (AMA), titled, “Why It’s Time to Say Goodbye to Traditional Budgeting,” which piqued my interest. If you’ve spent some time in the world of FP&A, you may understand exactly why. Every year, sometime between August and October, your neighborhood financial analyst may also be wondering if traditional, static, fiscal-year budgets are still needed and useful in today’s world of immediate access to endless amounts of real-time information. “Well, what else can you do?” is one response I got when I brought up the article during a conversation with a former co-worker. His answer: “evergreen” or “rolling” forecasts may be more relevant in today’s environment of rapid change.
In the article, the AMA cites a few sources and lays out three specific issues caused by traditional budgeting. Here is my perspective on these challenges, and a few key considerations for organizations who are rethinking their current budgeting process.
“IT TAKES A LONG TIME, COSTS TOO MUCH, AND CONSUMES TOO MANY CORPORATE RESOURCES.”
Managers, Controllers, Analysts, Accountants, etc. These are generic names for roles that are likely to exist at your organization. These are also a few of the roles that end up spending an enormous amount of time preparing, reviewing, revising and finalizing a budget. The organization’s focus becomes divided between managing day-to-day operations and meeting budgeting deadlines. As it turns out, purposely diverting focus from core business activities to budgeting for months at a time might be a bad idea for several reasons – one of which is that almost all of us stink at it. Simply put, we purposely spend a lot of time, money and effort on producing something that is likely going to be outdated, and possibly irrelevant within a month or two after final approval. In return for budgeting efforts, we are all but guaranteeing that our employees are not able to perform their best for the shareholders and customers. A cost/benefit analysis of the traditional budget practice set next to a viable alternative may sway the argument.
“IT’S FIXED, INFLEXIBLE AND CAN QUICKLY BECOME IRRELEVANT.”
In my experience, even the most thoroughly planned and well executed budgets are not the “real” goal of the organization’s performance. A few months after the budget has been accepted and communicated throughout the organization, myself or a colleague will be responsible for a model that is constantly updated to forecast the next twelve to sixty months of identical metrics. Since we have a model that sets financial and operational expectations for the next several annual periods, why not use that instead? It practically provides “real time” forecasts, takes into consideration all of the same drivers as an annual budget, and is already accepted as the executive communication tool for the “up to date” goals. If you rename one of those forecasts, “budget,” most of the resource-sucking practice of the budgeting process has now been eliminated. But, is a budget by any other name still a budget (Yes, I ripped that from William Shakespeare)?
“MOST COMPANIES TIE EXECUTIVE AND EMPLOYEE COMPENSATION DIRECTLY TO PERFORMANCE AGAINST THE BUDGET.”
While I don’t know if “most” is accurate, it wouldn’t surprise me if it this is the case for many organizations. Are all incentives positively aligned when the compensation of employees is set against an expense ceiling, or hitting a sales goal? It is possible that some organizations might hold sales targets lower as to not set too high expectations next year. Or they may want to inflate expense assumptions to set an easier goal to meet and exceed, if those expectations are accepted. As a result, the nature of tying compensation to budgets becomes such that organizations are not incentivized to produce the most accurate expectation of the organization’s performance. Efficiency and unit-based goals, versus the competition is an alternative. There are top performers in every industry that we can track our performance against. As a team, how well do we compete against other players in our market? This question is the one that we should probably spend more time considering.
If your organization does not already utilize some type of rolling forecast, then the scope and scale of change may be challenging to implement and adopt. I can’t think of an example of an industry where this transition isn’t possible – though it is never easy. There are many useful tools and programs that can help you navigate the treacherous waters of “budget season.” As you explore options, keep in mind the pace of change today. A software program that does not allow for non-fiscal year cycles may not be a great option; even if it is less expensive.
In terms of a rolling forecast versus a static budget – it starts on the top floor. The executive leadership needs to understand, accept and find additional value in the process. There is a lot of upside in the rolling forecast method. It will be hard for some to see the potential upside simply due to a natural reluctance to change. Others may not like the idea based on something more tangible. However, each perspective will have merits worth consideration.
My perspective: most businesses can benefit from rolling forecasts although not all businesses will experience tremendous incremental value. Either way, it can’t hurt to have the conversation and see what you can do to make next “budget season” more meaningful and less costly.
NOT SURE WHERE TO START?
We have a team of Finance & Accounting experts here at Bridgepoint Consulting that can help you with your budget needs. If you are implementing your first real budget, considering new budget and forecasting software, or exploring the idea of bringing in a resource so that your team can stay focused on their current responsibilities – we can help. Check out our service offerings and get in touch today!