For as long as most of us in Finance can remember, every year each company goes through its annual Budget cycle. Its as regular as clockwork, its ingrained in all of us to do it. But have you ever stopped, taken a step back, and asked why we do it this way?
ANNUAL BUDGETS ARE OUTDATED
Clearly in order to look ahead, its prudent (at least) to create a model of your business and make a plan of what the next year should look like financially. This gives a goal to aim at to keep the business on track, and allows us to plan ahead for changes that are likely to be needed. Typically this might be investment in capital items. hiring of new staff or launching of new products. It also serves to inform target setting for the sales teams, and gives everyone a common picture of what lies ahead.
This is all worthy, and necessary. However the idea that its done once a year, for a year, is deep rooted and based on assumptions that probably no longer apply.
Even 25, never mind 40-50 years ago, producing a budget was a manual, originally paper based, exercise. Many of us can remember the point where the “new fangled” spreadsheet appeared in the office and changed our lives. The idea of a once a year budget arose long before that point, but continues to this day.
A Budget looks at one fixed set of assumptions, for a fixed length of time, usually 12 months. There are almost no businesses where nothing changes for 12 months; or where just one set of assumptions can reliably predict outcomes over that period of time.
Surely the real purpose of a budget is not to place a fixed stake in the ground to aim at; but instead to consider what the likely outcomes will be if a particular set of circumstances occur. If the circumstances change, then the end result will inevitably vary. The objective of your business model is to give you advance notice of your direction, given a particular situation.
End decisions driven to 'meet the budget'
I once worked for a multinational corporation with similar self contained business units in each country. The exchange rates moved unfavourably one quarter, such that when the local company results were translated up to group (in USD), they were under performing against budget. In local currency, several were actually ahead of budget and doing well. But when viewed from the centre in USD they were below budget.
So management fired 20% of the staff in the local companies, in order to reduce staff costs, and “meet budget”. A quite stupendously stupid move, based on ignoring that circumstances (FX rates) had changed, and dogmatically aiming at a fixed point that was no longer valid. The local companies of course under performed next quarter as they had insufficient staff to fulfil the business demand.
Business no longer needs to aim at one fixed point. Instead it should be able to take a number of key indicators, and ask what the best performance of the company should look like in a given set of circumstances. The view of that best performance should change at the same pace as those of the key indicators. In some businesses that is weekly (a typical fast moving retail organisation) in some its several years (long term funded medical research). For most it is monthly.
The model should also test how critical the movement of certain items are – sensitivity analysis – and should look at a handful of likely short and medium term scenarios. But the key point is that the predicted result should vary according to circumstances; not stay fixed regardless of them.
This oddly, is true to the original philosophy of a budget. To predict a way ahead with some given assumptions. What has changed is both the speed at which those assumptions can change, and our ability to model different scenarios at speed.
planning means LOOKing AHEAD
With a modern planning tool, and a model that is driven by the correct key assumptions relevant for a given business, it should be possible to perform a full re-forecast in well under a week. For minor changes, under a day is entirely possible.
The concept of looking ahead is more critical than ever. The idea that it should be on one set of assumptions fixed for a year was probably never valid, and for a modern fast paced business it can be positively dangerous.