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Stay Hungry. Stay Foolish.

A blog by Leon Oudejans

Budgeting – breaking bad behaviour

30 January 2015


The budgeting process never stops to amaze me. Who is really interested in a budget? Either a budget is too soon and misses important Q3 or Q4 trends or a budget is that late that preparing the first full year forecast makes more sense for controlling the business. Auditors are hardly interested in the budget as it is beyond their scope. Some bankers may like receiving it but mostly for updating an internal checklist. For management the budget may already be past due while still preparing it. Supervisory directors seem to be the only exception to the above.

If you are really lucky the annual budgeting process process is swift and finalised well before the year-end. However, the budgeting process typically starts bottom-up, the outcome is usually rejected, and then a top-down approach comes instead with a limited alignment to the former bottom-up process. After many weeks of overtime, both managers and staff tend to be frustrated by the result.

Maintaining within – or surpassing – budget usually entitles various levels within the organisation to layered bonus schemes. The level of transactions before/at quarter-end or before/at year-end may even be explained by these bonus schemes. Managerial behavioural may actually change when a next bonus layer becomes within reach or when it’s totally out-of-reach.

Another frustration is the monthly variance analysis and the accompanying explanations. Most explanations tend to be dull and meaningless as transparant communication is either not welcome at the management board or at the supervisory board. These dull and meaningless explanations can be a recipe for time consuming discussions at management or supervisory board level about minor items. A special distraction is reporting variances due to errors in the budgeting process.

Disappointing net results cause a lot of discussions, meetings, questions and ad-hoc calculations regarding remedial actions. Unfortunately, management reporting (let alone financial reporting) is not a tool for establishing remedial actions. Most likely the information is available but the required data quality dimension (see next paragraph for example) of that information is not – readily – available.

In each (cost) controlling situation, another frustration comes to light: the unknown level of future committed and uncommitted cost (e.g., marketing cost). Contracts may be registered but usually in a fully independent database (e.g., Excel). I cannot recall that I ever saw a working interface from contracts to the General Ledger. Future – committed – cost are thus like an iceberg. Most is invisible.

Accounting (a.k.a bookkeeping) is focused on recording actuals (e.g., bank statements, invoices, salaries) and financial reporting (e.g., annual accounts). Controlling is focused on budgets, forecasts and management reporting. Major future (un)committed cost might be controlled by Accounting or Controlling in Excel spreadsheets. Timely, correct and complete information from other departments on future cost – or future turnover – is essential in establishing reliable forecasts.

In my view, the budgeting process needs to be replaced by a combination of contract management, scenario management, and ongoing full year forecasting. This would bring the required focus during challenging times and could help preventing the common chaotic human behaviour during crises.

Contract management would replace the essence of budgeting and would imply an annual agreement on the main business drivers: volume, average gross margins, marketing expense per unit sold, #FTE, total overhead. Substitution is allowed within each business driver. Variance reporting – while using thresholds – is only with respect to these main business drivers.

Scenario management would imply that management has pre-approved back-up plans for both rapidly deteriorating or booming market conditions. These back-up plans pre-identify areas for cost reduction – or cost expansion – following substantial changes in sales volume. In this way, little time is lost in implementing remedial actions. Usually lots of precious time is lost on discussions, meetings, questions and ad-hoc calculations.
Ongoing full year forecasting should become the key focus of the Finance Dept. including a brand new focus on committed and uncommitted future cost and turnover. Any forecast should comprise of year-to-date actuals, expected committed cost and turnover, and expected uncommitted cost and turnover. Thus the forecast would also become a tool rather than being a vital report.

This may well require a different aptitude and attitude within Finance as the Accounting domain and the Controlling domain will really need to cooperate regarding (recording) future cost and turnover. 


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