Every year around this time there is a collective groan in many organizations because they know it’s time to do a historic look back, clean up the dust and create the budget for the new year. This exercise tends to engulf whole organizations for months and often requires an army of people crunching away into the night. The exercise is so engrained in the company’s DNA that no one ever asks “what is the Return on Investment (ROI) on our budgeting process?” With efforts focused on making the process more efficient, rarely do organizations stop to question its objective, effectiveness and relevance in the new world. After all:
“If the ladder is not leaning against the right wall, every step we take just gets us to the wrong place faster.” Steven Covey
Let’s go back to the objectives of budgeting and look at some of the common challenges and realities that companies face:
Objective: Express in quantitative terms what the organization will achieve during the year; communicate the information as relevant to investors and the market; identify funds required to meet the plan; and cascade the requirements as targets to individuals within the organization.
Challenge: In a world where everything has become dynamic and ever changing, static goals are an anomaly. With multiple disruptions due to emerging business models, technology or world events, a year is an incredibly long period of time. To rapidly respond to opportunities or threats, managers need timely reallocation of funds and a reset of goals.
Objective: Pull together all activities of the organization in financial terms, and ensure discipline to channel spend such that all activities are tied to the strategic goals of the organization.
Challenge: All funds and resources are used in existing business or specified new business leaving little scope for new ideas or innovation. With startups innovating at the pace of speed, the majority of bigger companies are getting left behind.
Objective: Create awareness of strategic goals with employees, measure progress and reward behavior that leads to these goals.
Challenge: Appraisals and bonuses are based on budgets, leaving managers out of breath trying to meet set goals. They have minimal time to respond to market changes or try out new ideas. Such targets are also built to minimize risk rather than reward “positive risk taking”.
Software development went through a similar phase a few years back, leading to a replacement of the waterfall model of development with the “agile” model. An “Agile manifesto” was created to promote flexible planning and rapid response to change. If I were to reword the “Agile manifesto” for budgeting, it would look something like this:
At the outset, this looks impractical, infeasible and idealistic, but I predict that there will be tools that enable this
in the near future. Data science techniques already have fantastic iterative algorithms that lead to optimized outcomes. These will get applied to budgeting where every assumption, opportunity and risk is a moving piece linked to the budget and any changes will auto-update the budget on an ongoing basis to allow for optimized allocation of funds and flexible sub targets – keeping the end organizational goal the same. As a result, I believe there will be a natural death of annual budgets
Until this becomes a reality, here are some stopgaps companies are using to stay in the game:
Rolling Budgets and Forecasts: Some firms have already done away with the annual budget and moved to rolling or quarterly budgets where assumptions are reset and new challenges and opportunities factored in. To do this, it is important to reach a balance between direction and details.
Flexible Budgets: Some firms create budgets at an overall level rather than at a sub unit level. While budgets are used to communicate targets to the external world, the achievement of these then becomes a controlled internal exercise with managers having the flexibility to capitalize on new opportunities and allocate funds where they are most needed.
Balanced Goals: While the balanced scorecard has been in circulation for decades now, companies are now integrating it more effectively into the goal setting process to ensure inclusion of non-financial goals such as innovation.
The front story of The Economist
magazine this week is “Reinventing the Company”, and deals with disruptions to the traditional business models. In my opinion, “Reinventing the Budget” is an essential ingredient of success in this fast-paced environment.