Budgeting is something almost every company does and something almost everyone hates and mistrusts. Personally, I’m not a fan and lean strongly toward the Beyond Budgeting approach, but like nearly everyone I still run an annual budget process to achieve some specific benefits. I use the budget to reinforce the awareness of the current state. How much is needed to do what is typically done and why? I think this serves as a strong foundation for planning and management. I try to stay away from budgeting for growth or decline scenarios, though I do like to categorize resources and costs as those that are fixed within a typical range or those that are proportional to activity levels. I use this effort to increase cross organizational understanding, and to teach junior finance and accounting personnel about the organization by having them assist divisions with budget review/development. I like to push strategic and major initiatives into a strategic planning process where the senior leaders collectively agree on the goals, targets, investments, new resources, and the budgetary and performance impact…a separate effort from basic budgeting. My approach was develop by considering the ugly, bad, and the bit of good.
Ugly:
1. A competitive, top down budget process for resources and performance goals tends to make people into hoarders, hedgers, obstructionists, and basically liars. This sets a bad ethical culture, results in little learning but much frustration, and paves the way for lots of excuses all around.
2. Budgets tend to be inflexible when established in this manner, and often make organizations less flexible and competitive. In part, because no one can admit their lies and fabrications.
3. When truth is being shaded, budgeting must be done by the most senior people. This impedes organizational understanding and wastes valuable time and effort of managers and executives.
4. Unmet budget targets can unleash a blame game of competitive investigations and evidentiary claims that is destructive and unproductive.
Bad:
1. Budgeting for performance is often more about individual performance than organizational performance and profitability.
2. Fixed annual budget normally create a glut of marginally useful to wasteful year end spending as the organization acts to solidify their evidence for the next budget cycle. At best, valuable projects are often done later than they should have been.
3. Sales and Revenue can also be managed and manipulated to meet budget targets which disrupts numerous operations throughout the company and can result in legal violations.
Some Good:
1. Budgeting does remind nonfinancial managers to think in terms of monetary impact. Ideally, this is achieved in a way that builds trust, organizational & strategic understanding, flexibility, and teamwork.
2. Budgeting can help spread the details of organizational goals throughout the organization. Assuming the goals are realistic, reasonable, based on solid assumptions, and will change if these assumptions change- this can be a positive experience for the organizations.
What are your experiences with the role of budgeting to improve and increase profitability? Add a comment!
During my fifty plus years of observing accountants in action, I’ve noted that around 75% of budgets, forecasts and annual plans are primarily political documents, not planning tools. Their main purpose is to appease owners, lenders, or higher-level management so that those preparing the documents can keep their jobs and live to fight another day. I like to call this “The Scheherazade Syndrome” – telling a good enough story to keep you from being put to death in the next morning. This idea was driven home to me many years ago when I was still a controller in industry. I was reviewing a rather gloomy forecast with the CEO of my company when he broke into a big smile and said, “Damn it, Doug! If I get fired, I want it to be because of an actual, not a forecast. I’m sure either you or your successor can fix this thing for me.” It fixed it – one of my early works of fiction – and we both kept our jobs.
This leads to another time-waster for businesses; reconciling one budget or forecast with an earlier budget or forecast when neither one was based on any kind of economic reality. I see this all the time in the automotive supply industry. Some auto suppliers’ accounting staffs seem to be reconciling budgets and forecasts full-time. But even when they’re not political documents, budgets fall short of their intended purposes for a variety of reasons. Frequently, they’re just an exercise performed by an accountant in an office, not connected to any company strategy and based on a faulty economic cost model. Many times they’re obsolete before they’re published. They’re often bloated with ongoing inefficiencies or bags of sand added by savvy budget negotiators. Sometimes they encourage unnecessary spending because “if you don’t use it, you lose it.”
Effective budgeting and forecasting can be powerful tools that help managers make quality business decisions, but in the real-world organizations I’ve come into contact with over the decades, that’s not usually the case. For most, they are just two of the many political tools used by management to “play the game” and appease those who are looking over their shoulders.