Budgeting 2.0
It’s time to Rethink the way you Budget
The Current State of Planning
As we approach the end of 2021, most of you in FP&A teams are likely wrapping up your budget processes for 2022 (hopefully!), or perhaps have just run out of time and are settling with what you’ve got.
So, while the process is still fresh in your mind, it’s a good time to review how the current process is working. Or more likely, how it isn’t.
Most companies are still budgeting in an incremental way – starting with your current budget or actuals and flexing it a few % for the coming year. Which basically assumes the majority of costs in your organization will continue as is, give or take a few %.
But in our new world of rapidly rising costs and uncertain supply chains, how do you set a budget for the next calendar year? Since the only thing that is certain is that your products are going to cost more and take longer to get here! But how much more? How long? And what will happen to your revenue if you take price increases? What will happen to your margins if you don’t?
What data do you use when the accuracy of your historical actuals isn’t at the level you need, and you would be better off forecasting the future with a crystal ball?
My guess is you set the targets at what you hope you can achieve, or even worse at what your senior stakeholders have demanded, regardless of what you know you can realistically deliver.
Before we look at how to improve the budgeting process, first let’s dive a bit deeper into the current approaches you are likely using and review the shortfalls of each.
The Current State of Planning
The traditional way of budgeting and forecasting come in two forms.
The first approach is the complex bottom-up build; that giant excel file that has every possible assumption laid out across 1000’s of cells
This file is usually owned by one person, the excel guru who works magic, but is the only person who knows how the file works.
The second type is the YOY change template, where each department starts with last year’s numbers, and applies a % change, makes some edits and then you roll them all up and see what the answer is.
Of course, if you don’t like the “answer” with either of these approaches, you have to start over.
Let’s look at the shortcomings of the Bottom-up Build.
This is an example of MORE is not always better. This is a real-life example from a charity that has ALL the assumptions for their programs, to such a granular level, that there are now over 40,000 cells.
The problem with Bottom-up models is you try to make them so COMPLETE and accurate, they become too COMPLEX.
They start out as fairly simple models, the “cheap and cheerful” solution, and then they GROW. The files become massive, there are so many assumptions to keep track of it takes a huge amount of time to maintain, and you end up with errors because it’s all so complicated.
It’s a huge risk because all the information running the planning sits inside these huge files that often only one person knows how to work.
And in the end, you still just have one answer, because if you want to run scenarios, there are no simple levers, just one complicated bottom-up build.
Let’s look at the template model – one for every department, where you start with last year’s numbers, and then adjust up or down.
Some are excel only, many are excel that get rolled up into a bigger excel, or into a budget tool. But the same problems remain.
Each team is presenting their “answer”. The assumptions driving each department aren’t clear. Each template is just the answer prepared by each team of what they think is going to happen. But you don’t know the approach, what assumptions the results are based on, or the risk level. Some teams are experienced. Some might be brand new.
This can work in a reasonably steady environment where there aren’t too many changes. But most of the time, each team is making their own assumptions about what will change and when, and the assumptions aren’t aligned across all teams. Changing market conditions may be factored in or may be ignored if they bring potential bad news.
And it still takes a long time to do and ends up full of errors.
Finance still has to add all the templates together and you can’t flex assumptions if you don’t know what each team used as assumptions.
In my experience, most teams are focused on what they can “sell” to their boss, or what will make them look good. Many want to under promise and over deliver, others don’t want to look bad, so avoid mentioning bad news.
Current budgeting processes are very weak at delivering actual meaningful forecasts that reflect reality
In Summary
The problems with the traditional ways of budgeting
1 – Incremental planning process
2 – Start with some level of historical costs and layer on a % change
3 – Assumes you have the ability to manage external change.
You only need look at the commodity markets over the last 18 months to see how flawed the assumption is that you can control the level of cost change in the marketplace.
Disruption in production and transportation networks has created acute shortages in the automobile sector. Natural gas prices are at a 10 year high as inventories are low. The cost and timeline to import products has doubled or tripled for some. There are labour shortages, and disruptions as employees want to work from home or remote and are willing to change jobs to get that flexibility.
Depending on where your company falls in that mix of trends, applying a 3% flat increase in costs across entire categories of costs just isn’t going to cut it.
The days of simply setting budget targets once a year and then executing that plan are over. We need the ability to continuously plan as we get new information; we need to be able to run “what-if” scenarios and accurately model out the impact of changes in business strategies.
So how do we improve our Budgeting process?
So, who can you look to to see what’s possible in transforming your planning processes? The good news is you don’t have to reinvent the wheel. The leaders of the pack have already gone through a Finance transformation. What can you learn from them, so you can implement strategies and tools that are already tested and proven?
To understand what companies are really doing, we turned to a recent study of over 500 companies around the globe conducted by FSN, a Finance thought leadership group out of the UK. The study surveyed senior Finance leaders like yourselves across 23 industries about their planning capabilities. What did the survey results show?
Overall, companies are forecasting faster than in the past, but accuracy has deteriorated.
Two-thirds of organizations can reforecast within a week, but only 39% can forecast earnings to within +/- 5% accuracy.
80% of companies can’t look out more than a year.
Ultimately, a budget is a combination of your forecasting capability of what your current state is, combined with the incremental changes you plan to make.
If you can’t project with any accuracy the current state, it makes creating a budget of what you want to happen even harder. Budgeting is just one component of Planning. A moment in time where you lock your targets and often tie your bonus structures to these numbers. So they’re important – it’s what you get paid on!
But your actual planning tools and capability that you use to run the business and deliver results needs to be a suite of tools that allow for a continuous cycle of planning, that address your real time needs. What does that look like?
Transformation Improves Agility
To understand how transformation impacts the agility of planning, budgeting and forecasting, the survey compared the 5% of companies that have completely transformed their functions to the 14% that put no effort into it in the last 3 years.
What are the Transformation leaders doing that the rest aren’t?
What can we learn from the 5% of transformation leaders who have completely transformed their planning process?
How were they able to forecast more quickly, accurately and further into the future during a crisis?
FPA& Leaders are able to manage their data as a corporate asset rather than being overwhelmed by disconnected spreadsheets with poor data governance.
They have these common elements:
• One source of the truth for their data, that comes from a centralized business model, usually in the cloud
• They use more advanced tools like AI and visualization
• They place a premium on eliminating disconnected spreadsheets for data collecting and reporting
This enables them to implement rolling forecasts, zero-based budgeting and scenario planning.
Whether you choose to use all of these or just some, they ALL contribute to increasing the agility of the planning process.
Transformation experts are turning their attention to unifying and standardizing the budget process and managing the process in the Cloud, which will ultimately add to their already robust planning agility.
Foresight is a key component of planning and being able to see beyond a few months is a must. Transformation programs improve the integrity or trustworthiness of data, improve analytic capabilities, and enable faster and more accurate forecasting further out into the future.
So how can you do this in practical terms?
Continuous Planning
First, you need to move away from separate processes for each part of the planning cycle.
Planning teams and reporting teams have always been very independent, and seem to be focused on different priorities and projects at any given time.
The reporting team is rushed on month end or year end looking backwards, and the planning team is working with the business looking forwards.
Each team builds out their processes based on their own experiences of what has worked in other companies. It’s not surprising then that their processes rarely connect!
Next, you need to identify the key drivers of your revenue and expenses – the real levers that drive your business. These key drivers need to be the foundation of every one of your measurement processes – not your GL codes!
If you take the time to agree on the key revenue and expense drivers for the business and educate ALL the teams on the importance of getting the critical few right, you can hand off data from one team to the next seamlessly.
You need to agree on the key drivers, then build them into the budget, track them in your actuals, explain variances in the same consistent language, and then use that knowledge to inform your updated forecasts.
You don’t need fancy tools to improve your planning – it’s the discipline to take the time to design your process as an integrated whole, instead of individual cycles.
And once you have that, you have the foundation you need to successfully implement an integrated tool.
Discontinue Incremental Planning
You need to move away from incremental approaches that assume that if it was true last year, it’s still true this year. By doing a zero-based budget based on those key drivers, you gain clear visibility to the activities that are needed NOW, based on a current reality.
To do all that – you need better tools. We used to design the manual process and then automate it with the best-fit tools.
Now, the automation is what enables the better process.
It’s time to take advantage of the power available to you now – with data integration, workflows, and automatic updates. In addition to these powerful tools, now there is also the truly exciting capabilities of AI that powers our Virtual Finance Assistant (VFA), which is like having Siri for Finance at your fingertips.
Now more than ever, the finance team and FP&A has never been more important.
Market and business uncertainty is an opportunity for finance to play a more strategic role in the organization.
To become more strategic, the need to adopt more advanced accounting techniques such:
as Rolling Forecasts
Scenario Planning and
Zero-Based Budgeting.
These tools will help provide a more accurate view of the future, mitigate business risk, and help exploit new opportunities. None of these techniques are realistically achievable using manual planning processes and disconnected spreadsheets.
But they are turned into a reality when performed using a cloud-based Corporate Performance Management solution purpose-built for Budgeting, Planning and Reporting. CPM not only easily facilitates advanced accounting techniques, but it will also give you the added agility needed to become a proactive and strategic advisor to the organization.
It is so critical to invest in these tools before the next crisis hits us. There will never be a time when it’s easy to Transform Finance, just a time when with determination, resources and making it a priority, you can get it done.