6 Reasons to Hate Budget and Annual Planning Processes
Budget and annual planning cycle - these words can make many people tremble. Aimed at determining firm’s short-term objectives and transforming them into operational plan by allocating available resources, annual planning exercise is mostly considered by its stakeholders to be a curse rather than a savior.
There are many reasons to hate budget effort. Let’s jump to the most widely spread. Looking ahead, not only have I heard them all during my career in FP&A, but I also agree with most of them.
It takes too long. Indeed, it usually takes several months to run the budget cycle. Parkinson’s law works perfectly here: no matter how early you start the process, you will finish it exactly on the day of the final presentation.
Too many iterations. On average, companies build 5 versions of the budget before final approval. Being always associated with some level of uncertainty, the budget exercise may have numerous iterations as getting new information requires its reflection in the final version. Moreover, the earlier you start, the more iterations you will probably have. In fast-changing environments it may happen that by the time of approval, the budget has nothing in common with the first version. No wonder, stakeholders can merely recognize the numbers they will be accountable for next year.
Too many people involved. Not only the annual planning exercise takes much time, it also usually requires involvement of numerous senior-level business leaders and C-suite executives. Various studies show that senior managers spend from 10% to 20% of their time on budgeting while FP&A teams spend up to 50% of their time on it. Together with the first two points, it makes the budget cycle one of the most expensive business processes in the organization.
It rapidly becomes outdated. Usually focused on the performance during the next 12 months, budgets are often obsolete before they are even finished especially in the companies operating in highly competitive and dynamic markets. Nevertheless, yet outdated they are fixed and rarely modified while business conditions continue to change constantly. This creates a gap between the budget targets and business objectives in the new reality. If the targets set in the budget are no longer achievable, employees lose their motivation. On the contrary, if the objectives can be easily reached there is no need to accelerate as this may lead to the higher targets next year.
Too much game playing. During annual planning business leaders usually seek for modest incremental growth versus the previous year while executives insist on much more ambitious goals. Each side provides their arguments until they reach a compromise in these negotiations. Taking into account that annual targets very often serve as the basis for motivational programs and promotional perspectives, no wonder that business teams, first, aim for minimizing them and once they have been set, try to reach them by all means. This kind of process doesn’t motivate right behaviors, furthermore, it can damage business results and customer relationships. In pursuit of the achievement of the targets and maximization of bonuses, business representatives may put their personal benefits first and act not in their company’s interest.
It doesn’t help run business. Budget together with fixed annual targets place emphasis on financial performance rather than on the strategy. Managers are focused on reaching the year-end numbers rather than on adapting to changing environment with its new threats and opportunities. Business leaders may be reluctant to spend their budgets on strategic initiatives to meet the target or vice versa be wasteful to guarantee at least the same budget next year (if incremental approach is predominant in company’s budgeting).
These 6 reasons speak for themselves and can easily explain the total dissatisfaction with the budget process. The question here is why then we keep doing budgeting if it is so hated?
Despite heavy criticism of the annual planning process, budget is not necessarily a waste of time. According to the surveys 85% of finance professionals consider budget to be a valuable tool and 68% disagree that it adds little value.
Budgeting is a common practice: only 1% of the companies do not run annual planning process. Even if people are not optimistic and enthusiastic about it, budget is considered to be a necessary evil. Budget is a good communication tool as it perfectly represents financial goals and expectations of the company. Finally, setting fixed budget targets and measuring performance against them is an approach which is easy to implement, and which gives a sense of control over the results.
From the finance and FP&A perspective, annual planning process has at least one undeniable advantage: this is an amazing team building activity. Being an integrated process that requires input from every unit in the organization, budget cycle brings together finance function and all the other teams of the company. This is a great opportunity to deeply understand how the business is operating and what the main challenges and growth options are, this is a perfect moment to build relationships with other departments and gain trust of the FP&A’s internal customers to become their first or maybe even single point of contact regarding financial questions, this is the time to develop and demonstrate your leadership skills and get your seat at the decision-making table.
Budget exists for over a century and many organizations do not even think of giving up this practice. The problem may be not in the tool itself but in the way it is used. There is always room for improvement. Understanding major weaknesses of the planning process it is possible to shape the budget and adjust it to the needs of the company to overcome these flaws that cause stakeholders’ dissatisfaction.
For example, to address the issue with the length of the budget cycle, number of iterations and time-consuming efforts, try to reduce the level of details and turn to aggregated budgets built around the most important product groups, processes and costs. This will contribute to better flexibility and speed in decision-making and will keep management team focused on the key performance drivers.
After having got rid of the detailed model and moved to a lighter version of the budget, continuous planning in the form of the rolling forecast can take its place. This will help to overcome the drawbacks of the outdated budgets and lack of the support in running the business: teams will be focused on the future rather than on the year-end and be able to adapt to changing conditions on the market.
To support this shift, fixed targets should be replaced by the relative ones, for example, based on the benchmarks. In this case only the estimate of the targets can be made, business leaders do not know them in advance, this motivates right behaviors and encourage employees act in the company’s best interests.
Budget has always played an important role in performance management and control. Lately it has been heavily criticized for being one of the most ineffective and inefficient management practice. Straightforward approach with fixed targets may result in total dissatisfaction of all the participants while tailored well managed budget cycle may open new horizons for the FP&A team. Leading annual planning process is one of the core activities of the FP&A function and is undoubtedly a tough task which can either make you or break you. Awareness of all the drawbacks of the budgeting together with the willingness to overcome them can provide FP&A teams with enormous opportunities to become better business partners as well as develop leadership skills.
References:
1. APQC’s Open Standards Benchmarking® Performance Assessment in Planning and Management Accounting
2. Why Budgeting Fails: One Management System Is Not Enough by Prof. Péter Hovàth and and Dr.Ralf Sauter, Balance Scorecard Report September-October 2004.