Traditional budgeting is a broken tool, particularly in a more volatile business environment. The biggest problem with most traditional budgets is that they are based on a bunch of assumptions. Assumptions about what the economy is going to do, future competitive actions, future customer responses, governmental changes, currency movement and a whole series of things. The majority of this is outside the control of the organizations. When these assumptions turn out to be wrong, the plans based on them pretty much are wrong as well. As finance professionals, we rigidly want to adhere to those plans and do monthly variance explanations when we are not inside the line. Had we known the changes that were coming our way we would never have drawn the lines in the first place.
Top 5 problems with Budgets
1. Budgets are time consuming and expensive. The average time consumed is between four and five months. Some organizations have attempted to place a cost of the whole planning and budgeting process. Ford Motor Company figured out this amounted to $1.2 billion per annum.
2. Budgets protect rather that reduce costs. “Use it or lose it” is the manager’s mantra. Not spending the budget is a cardinal sin in most organizations. Spend up to the budget to preserve it for the next year. This attitude actually cost the organization more money. Although management will not spend more than the budget allows, you can bet they won’t spend a penny less either.
3. Budgets stifle product and strategy innovation. Budgets are said to be a barrier to change and innovations. Budgets can result in short term decisions to keep within the budget rather than the right long term decision which exceeds the budgets.
4. Budgets focus on sales targets rather than customer satisfaction. Managers can become too preoccupied with setting and reviewing budgets and forgetting to focus on the real issues of winning customers.
5. Budgets lead to unethical behavior. Managing the results (also known as cooking the books) is a frequent outcome of budgeting. Many finance managers are well versed in managing the slack” and feeding it into the results when needed. However, as we have see, this practice can border on outright fraud.
So no more budgets. In its place: a rolling forecast, something more flexible, adjusting as the environment evolves.
Rather than locking into an annual budget, use quarterly financial results to update a 15-month outlook, constantly looking at it in chunks and trying to make sure your numbers are trending where you think they should trend. So you know if you have a whole bunch of expenses coming up, you can adjust your forecast and make other adjustments in the organization to allow for that.
This way the forecast revises itself based on the most recent results. It’s a living, breathing document, and it’s more in tune with what reality is becoming.
In recent years, an increasing number of companies have eschewed or amended traditional budgeting techniques for a more flexible approach. Spending less time on a budget and more on analyzing performance benefits a company in the long run.