FSN: Budgeting: Is there Method in the Madness?

Budgeting: Is there Method in the Madness?

12th March 2007
“Making a budget is an exercise in minimalization. You're always trying to get the lowest out of people, because everyone is negotiating to get a lower number.” This was how Jack Welch, CEO of GE, famously articulated an angst that will resonate with many people who have participated in the Budgeting process of a large organisation. But why does this cornerstone of Performance Management inflame such strong antipathy? The answer to this question lies in stresses that Budgeting places on management – and on the systems that support the whole process, says Mark Stimpson, FSN senior writer.

On the surface, Budgeting appears a straightforward and worthy exercise. Once high-level goals for the enterprise have been quantified as part of a Strategic Plan, Budgeting attempts to align the entire management team with the Plan by breaking down these targets – at least, those covering the next 12 months – to a departmental level, so that every individual knows how they will contribute to the success of the organisation.

However, Budgeting processes become dysfunctional for three main reasons: firstly, in a vain attempt to drive accuracy, budget administrators demand too much detail; secondly, budgeting is performed in organisational silos that ignore the interdependencies between business functions; thirdly the budget is used as a benchmark that influences performance appraisals, remuneration and career prospects, giving the whole exercise a fundamental conflict of interests. These factors place considerable strain on budget-holders and it is little wonder that many iterations are required before the budget proposals of individual cost centre managers (the ‘bottom-up numbers') reconcile with the high-level targets (the ‘top down numbers') demanded by senior management.

Budgeting has historically been one of the most commonly-found applications for spreadsheet software. Although there are obvious reasons why this is the case, the dysfunctional Budgeting process has only served to place the shortcomings of spreadsheet programs in the spotlight. Richard Buettner of Infor neatly encapsulates these failings, commenting, “Spreadsheets run out of steam because of the "Four C's". Complexity issues, because detailed level with many contributors leads to hundreds of linked spreadsheets. Capacity issues – a standalone spreadsheet is not a database, so storage is limited and it is difficult to cope with the detail required. Consistency issues arise because spreadsheets on different servers and file systems mean that changes are not propagated correctly from one budget to another. Communication issues, because spreadsheets lack the built-in workflow capabilities to manage an enterprise-wide budgeting process.”

It is little wonder then, that the Budgeting cycle is usually a top priority for companies implementing a Performance Management system. This view is confirmed by Frank Pizzolato of Clarity Systems, “The place where most people start is with their broken budgeting process.” This is not surprising, given the sheer effort involved in pulling a Budget together in a large organisation – often tying up considerable management time for several months each year. Usually, it is the data collection element of Budgeting that is the prime focus of attention. “Once they've decided to tackle the Budget process, they quickly move on to question the amount of data they are collecting,” continues Pizzolato, “they want to know: Can we reduce the amount of budget data we're collecting by moving to a driver-based approach?” The use of driver-based models has indeed been a key actor in slashing the effort required in budget preparation. Each manager only needs to predict a few key variables - such as headcount and sales volume – then rely on formulae defined in the budget model to generate the bulk of their figures. This not only saves time – it also gives senior management some insight to the assumptions that underpin budget submissions.

Of course, if it were a matter of defining a few arithmetic relationships, the humble spreadsheet would be an ideal medium for this process. But, as Andy Nelmes of Cognos points out, life is not that simple: “The budget is typically a network of interlocking pieces.” The Sales Budget defining the sales teams' intentions for the coming year is often a starting point for the Budgeting process. In another part of the organisation, those responsible for meeting that demand will be preparing some form of Manufacturing or Capacity Budget. Interweaved with these processes will be others to compile budgets for Capital Expenditure, Administrative Expenses and, depending on the industry, specialist areas such as Research & Development. “Each component of the Budget across the enterprise has touch-points with the others,” Nelmes told FSN. “It's important that they are kept in synch through each iteration, to make sure that decisions around the budget are being made on a consistent basis.”

This consistency is more easily ensured if the number of cycles in the budget process is minimised. “It's not unusual to find companies running through ten iterations or more to arrive at a finalised Budget,” continues Nelmes. “Every cycle adds a lot of time to the whole process, so workflow management is critical. In fact, good visibility to how the budget process is progressing and the data being submitted can actually reduce the number of iterations needed.” Poor data quality is another factor that forces additional budget cycles, so in addition to managing workflow, an efficient budgeting system needs effective data validation capabilities that trap any obviously erroneous data values at source.

But what really sets Budgeting apart from high-level Planning is the sheer scale of the number-crunching it involves. In a large organisation, thousands of managers will participate in creating a Budget. Each will contribute budget data covering tens or even hundreds of line items, phased by month – or even weeks – covering a period from one to two years. This means that capacity – both in terms of numbers of users and data volumes - is one of the key attributes that Budgeting systems need to offer. It is also, as Richard Buettner points out above, an area where spreadsheet software struggles to cope.

Given the size of the Budgeting problem, it is not surprising that this is where the Finance function first looks for Return on Investment from a performance Management system. It is also the reason why many view the Budgeting process through jaded eyes, questioning the business benefits of such a resource-hungry process. This scepticism is demonstrated by the Beyond Budgeting Round Table, a widely-respected think-tank promoting more enlightened approaches to performance management. In their book, “Beyond Budgeting” the leaders of this movement, Robin Fraser and Jeremy Hope point out that “ The budgeting process has much to answer for. That it is too long, too expensive, and adds little value is not in doubt. Nor do most managers need much convincing that it is out of kilter with the competitive environment.” Nevertheless, many organisations remain reluctant to give up the “comfort blanket” of the familiar budget process, without a clear idea of what will take its place – a feeling reinforced by the demands for tighter management controls that have emerged in the era of Sarbanes Oxley.

The control that companies seek through Budgeting usually manifests itself in Variance Reporting. “Once the budget cycle has been optimised, CFO's start to focus on the value of actual v budget comparisons and capturing forecasts and re-forecasts,” comments Frank Pizzolato. Whatever targets have been quantified as part of the Planning process, and however these have been delegated through Budgeting, it is actual performance that measures the success of an organisation. Keeping one step ahead of the ‘actuals' and where they are headed is the focus of the Forecasting process, to be covered in the next article in this series.

Related FSN articles

What tools are you planning on?
Are you Planning, Budgeting or Forecasting?

About Us