Come January and many companies will commence the annual ritual of the Financial Budget. Last year Budget will be dusted off, actual year-to-date performance will be reviewed, next year performance target will be demanded from business heads, numbers will be negotiated, financial planning and analysis (FP&A) folks will crunch and consolidate and voila, the EY 16-17 will be ready!
Certainly, this is how the ‘classical’ budgeting process works. But is this how companies now do their budget today? A large number of companies no longer follow this approach and even if they do, the Budget is no longer the ‘Holy Grail’ of annual planning.
Here are 5 reasons why.
1. A Year Is Too Long
For most companies today, 12 months is a very long period. In a VUCA world where it’s hard to take a call on business realities of the next few weeks, how credible or solid can one expect an annual plan to be? Several companies recognise that uncertainty is now a way of life and treat the annual budget as an useful ‘directional’ exercise, but have implemented rolling 3 months forecast as the real tool to measure performance against. Yes, at the end of the year, a comparison with the Budget is still done. But during the year, the ‘goalposts’ change, and that’s perfectly fine.
2. I Have Evolved Beyond A Financial Budget
Businesses which are older, more stable, have a past historical base that allows predictable future performance. These businesses have a known and limited set of business variables and understand the interplay between these variables. They find pure financial budgeting of limited value. These businesses recognize that financial performance is merely an outcome of managing key levers or causative factors, which are usually enshrined in an Operating Plan. They have strong internal consensus on the levers to be measured, sharp measurement and monitoring mechanisms, regular review processes and efficient TAT between problem recognition and implementation of corrective action. Mature businesses therefore find tracking against Operating Plan more useful than a pure Financial Budget
3. I Don’t Know What To Budget
A common problem for younger companies, particularly start-ups is the nascence of their business model. This results in lack of clarity around the business levers itself. Such companies need to be ‘playing’ with the levers to identify which ones are key, experimenting with sensitivities in the model, figuring out which levers impact results by how much, understanding the interplay between levers, and figuring efficient ways to reach critical mass to prove pace and rate of concept adoption by the market. Budgets in such companies are most often used by Promoters and Investors as means to estimate cash burn. The classical Budget P/L or Balance Sheet is less critical.
4. Slaves of an incremental mindset
Several companies now see the Financial Budget as an exercise in incrementalism, where consciously or sub-consciously, companies end up projecting growth based on a base from the past. While this exercise is not entirely without value, it does hinder ‘opportunity led’ thinking. Companies are opting to size the market, and use planning time to estimate what their share of the market can be and how quickly they can get there. A change in philosophy on how to view the planning process has resulted in the financial budgets becoming less valuable in these companies.
5. Budget as a tool, and not an end in itself
Increasing number of companies see the Budget as a means to an end and not an end in itself. The emphasis is on performance and not on ‘ritual’, on results and not the activity. Companies chose to invest time in executing the plan, and finding better ways to execute, rather than perfecting the plan, especially in times where the perfect plan does not exist.
So, are Financial Budgets dead? Probably not dead, but certainly in an ‘ICU’, atleast from a classical budgeting standpoint. Importance of a Financial Budget from a planning perspective, certainly seems to have reduced, given the challenges around ‘one-time’ annual planning in the context of highly volatile business variables have become. From a control standpoint, budgets continue to be useful for CEOs, CFOs and BU Heads to manage costs. What is certain is that FP&A folks need to be on their toes year long, helping businesses find newer and quicker ways to measure, monitor and control performance better. The age of the budget as an ‘one off’ exercise and ending with a rigid plan for the next 12 months is over.
Happy planning for FY 16-17!