“Doomsday has come, the GFC is upon us, slash the budgeted headcount”, came the cry from head office. “But we can’t possibly,” responded the local team, “our people are our most important asset.”
A good budget process should consider all the moving parts of the business. In our example, those that focussed solely on revenue / head, were left scrambling. Consultants had been laid off, deadlines missed and the clients weren’t happy. Leads had dried up and profits were down. Other businesses looked at ways to change their underlying activities and improve productivity. Revenue / head was improved, but importantly, the business now had a clear idea of the changes they needed to make to improve profits.
When our planning process focusses on results as inputs, we miss an opportunity to set ourselves alight.
There are lots of ways to run a budget process. It’s not a new area, businesses started formalising their planning around the time of the Great Depression as a means of controlling costs (Berland et al. 2009, as cited in Lorain et al. 2014). Revenue now plays a significant part in the process, with management bonuses often based off sales targets.
A TRADITIONAL APPROACH
Budgeting and planning are generally managed through the finance team. It can be as simple as taking last year’s results and making a few adjustments. In larger organisations, the planning cycle will include input from the manager of each business unit. This is designed to motivate and incentivise managers and align them to the organisation’s goals and strategies.
At the end of a sometimes lengthy process, the budget is signed off and locked in place. The financial results can then be used to measure future performance. Forward thinking companies are adopting new models to address common issues found with the traditional approach:
Static nature of results
Overly detailed: time spent on areas with minimal financial impact
Insufficiently detailed when considering day to day activities and relationships between them
Driver based planning builds up the budget by developing a clear understanding of the cost drivers of activities undertaken by the organisation. A well-structured driver based budget will focus on the key variables that have significant influence on financial outcomes. An example:
This gives marketing, sales and operations focus for the coming period. It allows budget variances to be measured against specific components.
Risk adjusted planning is an approach that generates a range of possible scenarios based on an analysis of multiple risks. The method provides a perspective on the business’s risk profile and associated financial exposure.
While these trends allow greater analysis to occur in the planning process, they do not always address the fact that budgets can quickly become outdated. Rolling forecasts extend the budget model beyond the fiscal year for a standard number of periods. They are updated on a regular basis and blend actual performance with the updated outlook.
RECOMMENDATION: ADOPT A COMBINED APPROACH
Listed companies have large finance teams, BHP have thousands of finance professionals spread across the business. Considerable time is spent on the planning process. While budgeting is important in an owner operated business, it would be folly to implement the same process as BHP. However key features can be adopted to ensure maximum value is obtained.
Ensure your budget process:
Is built up using key activities
Assesses results as outcomes not inputs
Can be updated with new information
Contact us to receive future posts showing how a customised financial model can assist with this process.