The problem with traditional budgets

Traditonal business budgeting is anti-growth. It lowers performance, wastes time and causes lost opportunities. The solution is to simplify.

The big-budget solution is sophisticated real-time technology and power analytics. But money is not always the answer. In our experience, the solution is to simplify and refocus.

GrowthPath's founder, Tim Richardson, was Finance Director for a number of Philips factories in Europe in the midst of a rising Euro, cheap Chinese competition and the emergence of Carbon trading trading (sound familiar?). It was a high change environment. The business was under enormous pressure from customers (looking for prices to match imports flooding through low-end retailers), regulators (worried about factories closing), costs, competitors and currency.

It became obvious that our strategic planning and detailed budget process had become a bad joke. Why?

• The traditional approach used an outdated financial model: it didn't clearly separate fixed and variable costs, and too many overheads were treated as per-unit costs

• The traditional P&L is very democratic. Each account get equal space, no matter how trivial or uninfluenceable it is. Focus is taken away from what's important

• The traditional approach is very time consuming to make, update, argue-over and explain

Traditional budgets are more concerned with tax returns and annual reports.

They don't model what really drives a business. Too much time is spent explaining why real results have deviated from the budget. Those explanations quickly become almost ridiculous: real results are restated to be "comparable" to the budget on the basis that this is what would have happened if only financial markets and competitors obeyed our budget assumptions.

An attempted solution: Rolling Forecasts

Some businesses try to fix the time waste of budgets with expensive software, which is great for vendors. Other businesses have tried different approaches, such as Rolling Forecasts.

Rolling forecasts admit that the world changes so let's generate a new budget every three months.

But what happens if senior management targets stay fixed to the annual, one-true-budget? Then everyone is trying to explain what happened against two different sets of numbers. One step forward, but two steps backwards.

Philips had a "Beyond Budgeting" phase. Rolling forecasts made the budget officially just another three month snapshot (as a warning of what was to come, it was given a special name: "The Annual Operating Plan" when it should just have been the October rolling forecast). Philips tried hard, but the organisation couldn't move "beyond" annual targets. The budget 'special' October rolling forecast was the basis for bonuses. The rolling forecast didn't replace the budget, it just became another layer. Now. the monthly reporting was full of reconcilations to both the budget and to the latest forecast. The problem started at the very top: shareholders didn't want the board following new targets every three months.

What works: radical simplication

Then the penny dropped that rolling forecasts were giving more accurate forecasts but not helping improve business results.  In effect, we were looking backwards more frequently.

So it was scrapped. The replacement was a simple one page format which was based on business drivers. An eight week process became two weeks. Countless hours of management talent was liberated to improve the business.

The move allowed contribution margin reporting, and enabled much, much faster decisions. 

If you're operating in a dynamic environment, like Australia, business should move to a much more streamlined approach. At the very least, don't base budgets on a financial accounting model (the P&L). We recommend aiming for radical simplification. If a huge, vertically integrated and complex listed business can do it, then for smaller firms it's a walk in the park.

Read more:

CFO Magazine Goodbye Budgets: Goodbye Budgets