Broadly, there are three main objectives for creating the budget, as it unfolds in most organizations:
Lay down the financial targets for the following year at the functional, business and geographic level
Provide assurance to the board of directors and management that the company is on track to achieve the medium-term strategic plan/vision
Provide a set of measurable metrics at various levels of the hierarchy to effectively evaluate individual and team performance
With the above objectives in mind, here is a seven-step process to re-engineer your budget process.
Step 1: Think Afresh
The very first and one-off step is to create a Process Transformation Working Group to revamp the entire budget process. This group should include members from across the organization, with all parts of the business adequately represented.
The group should be “let go” for a period of two to three days to work away from their business-as-usual responsibilities and dedicate themselves to the process re-engineering. They should be given the necessary authority and independence to challenge prevalent practices.
The group should be encouraged to think afresh, on a white board. The key is to not start with the problems in the existing process and then attempt to fix them. Going to the drawing board means starting with a zero base.
If you were constructing the budget process today for the first time, knowing all that you know, how would you do it in a simple yet effective way? This is the question to ask.
It is important to aim to create a simple process for the organization to adopt, while keeping the focus on achieving the three objectives above.
Step 2: List Milestones and Timelines
There are some tasks that impact the organization as a whole and that need to be performed at the very beginning of the budget cycle. For example, in many industries, a report that provides an overview of the economy, the market and the pricing trends expected is key to kick-start the budget.
It is critical that this overview is provided to all relevant businesses and other parts of the organization early in the process. Likewise, estimated wage increases for the coming year for different regions would need to be finalized and handed to all departments engaged in the budget.
Clear timelines have to be laid down as well. There ought to be a definite duration to the budget process, and this has to be applicable to every business and function across the organization, irrespective of hierarchy.
The start-date is important and the end-date more so. A fundamental flaw in most of the budget processes I have witnessed is the lack of a definite end-date. People tend to believe that they can carry on with the budget process as long as it takes.
Step 3: Communicate and Communicate Some More
This is perhaps the single most important step to get right in the budget process. Irrespective of the size of the organization, communication plays a vital role.
Everyone has a part to play to make the process successful and hence this is key. It is extremely important to come up with a well articulated budget plan with clear timelines and communicate the same well to all key stakeholders.
Spending a couple of extra hours explaining the process to the most difficult stakeholders is definitely preferable to having to backtrack on certain elements of the process at a much later date.
Step 4: Set the Right Expectations
Being transparent about the organization's financial objectives is essential to ensure that the people at the ground level are pushing forward with the intensity that management desires.
High-level indicative targets should be obtained from the Executive Committee or the board and communicated to the businesses and countries. These targets should include revenue growth, expense growth, balance sheet growth, sales volumes and new customers.
Individual businesses can then work their bottom-up budgets with these high level targets in mind as goals to be achieved.
Within the overall organization target, individual business units can be given the flexibility to configure their budget in a way that makes it realistic. Not every unit needs to work towards the same uniform target.
For instance, in the case of a bank, the consumer business may be given a target of 18% revenue growth. Some units within consumer business may be capable of delivering only 10%, others may be able to achieve 25%.
As long as the overall target for the consumer business is met, business unit heads can wield this flexibility – ensuring a greater chance of a realistic budget being built within the timelines specified.
Step 5: Require Only ‘Level 2’ Detail
One of the requisites of a successful top-down budgeting approach is to track the work being carried out at the ground level. So the general tendency of each business is to create a budget starting at the very bottom, working in even the minutest of details.
This is not ideal when targets are still subject to change. There is no point in carrying out elaborate work while the targets are still being shaped. Asking only for limited detail at this first stage helps to avoid wasteful time and creates less angst at the ground level (see below for more details).
Once there is agreement on the numbers, a greater level of detail can be sought to ensure that the underlying drivers fit in well with the high-level numbers
Step 6: Aim for a Minimum Number of Submissions
A tested approach is to require only two submissions. One recommended process flow is explained below:
Dissemination of high-level targets. This is a key step in getting the budget process rolling. The Board has to clearly communicate the expectations to all the businesses/functions.
First submission. This contains the bottom up ‘Level 2’ information referenced above. Staying with the example of the banking consumer business previously discussed, this would mean the following.
Let’s say the Consumer Division has a target of 18% revenue growth and 15% cost growth to deliver in the budget. Under Level 2 submission, it may be decided that detailed per-product P&L numbers may not be required. Only revenue figures will uffice, with costs aggregated at the division level.
Alternatively, while revenue may be split by product, this may be done on a best-effort approximation basis, rather than based on detailed underlying drivers. This approach can save a lot of time and effort, while at the same time expediting the submission process.
Debate and discussion. A two-day meeting may thereafter be organized, where business units/countries present their case to their business heads/country heads/regional heads as to why they can or cannot meet the targets. In this meeting, the targets may be discussed, revised as appropriate and agreed upon.
Revision of targets. Management may then agree on a revised set of targets, based on the two-day session. Those targets may thereafter be reissued as the final targets.
Second submission. Once the final targets are issued, business units may make their second and final submission.
Driver details. Elaborate driver details may be sought, once the high level P&L and other targets are agreed upon, to ensure that the underlying drivers sync up well with the top-line numbers.
In some organizations, an additional round of discussions may be required, depending on the size and complexity of the business involved. An exception may be granted on the two-submission rule, but this should be on an as-required basis, not a blanket option.
Step 7: Lock the Budget
Once the final submissions are in and the driver details are configured, the budget should be formally announced as closed. If it resides in a financial planning and reporting system, then the budget should be locked for all practical purposes.
This should happen well before the start of the new financial year.
The budget is, of course, constructed based on a set of assumptions prevalent at a point in time. Hence, it is important to recognize that its applicability in its current form can change, depending upon uncontrollable external factors.
The performance management process should provide for the impact on the financial statements of changes in the variables in the external environment. Generally, the onus shall be on the respective budget owners to prove the impact.
Of course, when there are huge variances in, for instance, exchange rates in an organization that deals with multiple currencies across geographies, the impact would be obvious and affect all businesses.
The truth about the budget is that its validity gets progressively diluted as the financial year rolls on. Developing a monthly or quarterly rolling forecast is hence key to ensuring that teams can update business plans and stay attuned with the marketplace.
A rolling forecast is a supplement, rather than a substitute, to the annual budget.
The budget is a 'point-in-time' annual target issued at the beginning of the financial year to the organization’s various teams. A forecast is more current, a continuously moving target that blends in actual financials of the months gone by.
It represents a reality check for actual financial performance, a bridge of a sort between the budget and actual results.
Forecasts are essential to ensure that the organization is firmly grounded in the current context, while the budget that was locked at the beginning of the year provides a reference point to the organizational goals and a link to the medium-term strategic plan
Role of Technology
The process of financial planning has almost always relied on manual spreadsheets to construct a budget. Usage of automated tools has been relatively sparse, in part because the budget process is seen as too unstructured for a ready-made software solution to handle or because the business is considered too complex with multiple variables.
However, new technology solutions and platforms are coming to market that are touted as proving useful, particularly in large organizations. One postal company in Australia, for example, had implemented an enterprise planning software that it says is working reasonably well for budgeting.
The company had decided to move to a driver-based planning approach to allow greater transparency into the underlying drivers and assumptions, while also aiming for flexibility to analyze and change the plan in short time frames.
This required an intuitive interface, comprehensive training and a well laid out process to cascade the high-level targets to individual cost centers and the account level. The automation tool also had to be integrated with the ERP system, be able to extract data and meta-data, and allow new accounts and cost centers to be synchronized daily.
An elaborate blueprint of the budget model was constructed from data source – whether a system input or a manual input – through to the final calculations on the financial statements. Necessary software upgrades were made to deliver the output as listed in the blueprint.
As a result, the finance team was able to save significant time and manual effort. They were also able to make better decisions based on accurate and timely information, enabled by the real-time recalculations by the software.
Ahead of the Game
In summary, organizations would do well to invest in a one-time dedicated effort to transform the budget process into a highly productive one. One that can generate value for the organization, without having to spend endless man hours to construct it.
And the icing on the cake would be the 'real time' information feeding bottoms up into the budget model to enable top management to simulate 'what-if' scenarios and gauge impact of unknown or uncertain variables.
CFOs and organizations that are willing to invest in revamping their financial planning effort will hold an edge over competition. They will be freeing up employee time spent on endless spreadsheet iterations to focus on revenue- generating activities. They will also enable faster management decisions based on real-time information from the bottom-up.