Optimising budget efforts with modern processes, mind set and tools
Posted by Stéphane Bonutto
The budget process still requires a high degree of time and effort, which risks creating an outdated financial picture before the year starts.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
In summer, a number of managers close their laptops 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 KPI’s have been dictated. Now the finance team simply 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 start returning to the office, post-holiday, the first budget draft does not quite meet the expected profit levels or performance KPI’s. This means it is time to quickly adjust some cost assumptions, like FTE’s 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, right?
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 that have been 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 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 probably creating the illusion of knowing the future, especially since the latter budget months are very far ahead at the time the budget is drawn up. On top of this, traditional budgeting lacks flexibility and cannot react to the unforeseen, especially to changes in the market. 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 mind set, 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 - that enterprise 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 certain 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 for 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 a one single version of deliverables. Top management, as the champion of modern budgeting, 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 headwinds on revenues and deliver the budgeted result.
Calculating one budget scenario is already a very broad and complex exercise, considering the re-calculation of cost and profit centers, legal entities and business divisions etc. Therefore, calculating scenario based budgets in order to return a landing range of profitability will require powerful ERP and BI tools to process the quantity of data. It appears crucial to save as much effort as possible on data entry, so that finance staff can take their work up a level. They are then left to focus on agreeing budget drivers, holding discussions 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 solely the opinions and perceptions of the author, and in no way commit his current or previous employers to his ideas.