Have you ever been
trapped in the preparation of an annual budget that is being changed every few
weeks and you can never wrap it up? Have you ever dreamt of completely doing
away with the annual budget of the company you work with? Would you embrace the
idea of replacing it by easier to do rolling forecasts? That was the main idea
discussed in the IBM Finance Forum 2013. Tempting? By sure it is! The idea of
erasing annual budgets from the list of activities is at least “sexy” for those
of us who have suffered the preparation of never ending budgets. Replacing it by
rolling forecasts, which would be continually updated throughout the year, is the
equivalent of replacing a mega activity that consumes a considerable amount of
effort and generates a peak of work, by a series of short routines, evenly
distributed through the calendar, and focused on the critical -and more
volatile- variables of the business.
Sounds good so far?
Well, it gets better. In an increasingly volatile and competitive environment,
annual budgets begin to look like a straightjacket when you want to give a turn
to your business. For example, If you are in the middle of a fiscal year, and
decide to change the pricing strategy that was envisaged in the budget, or not
to launch the new product that was planned to be launched, or to postpone the
opening of a new store for 6 months, waiting for more favourable conditions, the
possibility of achieving the goals set in the annual budget would be seriously
compromised. In a rapidly changing economic environment, with a lot of pressure
from new competitors (many of them global), and with technological changes
every second, it is not surprising that the budget of the company could be
completely obsolete in a few months, and sometimes even, after few weeks of
starting the new fiscal year.
No wonder then that
the idea of replacing the
annual budget by a process of continuing re-forecasting the business, in order
to amend estimations every time that the market conditions change, looks so
appealing. Moreover when business
intelligence systems and technology enable and facilitate these changes.
However, it is not so simple. Its implementation involves a cultural change which
affects the entire company, not just those who traditionally are involved in
budgeting.
The company's annual
budget is a planning tool commonly used to align business goals. Rather than to
forecast the future, the budget is set like a target to be achieved. It is used
as a reference to determine individual goals, and employees’ annual bonuses. Very often the annual budget is the
core of the employees’ incentive plans. It is also used to control the appropriate use of funds and resources, especially
in governmental and public funded institutions. The annual budget could be
eliminated from the task’s list, but something needs to fulfill the role that
it is playing.
At the end,
we are talking about changing the Planning Cycle. One option is to move away from
the old annual cycle to a new one
which is continually updated. Every time that something relevant in the
business changes, a new forecast is produced. According to the IBM Finance
Forum’s speakers some large and famous corporations –labelled by them as leading
companies- have already replaced budgets by rolling forecasts and are happy with
their decision. With some scepticism, I am guessing that they have changed an
old headache for a new one that seems to make more sense in the current
business environment.
My own experience
tells me that the annual budgets are based on assumptions that are continuously
changing. Those premises change several times during the budget process forcing
to produce different budget versions before “the final” one is published. Once
published, the assumptions start to become obsolete as the reality very often
refuses to follow our budgeting path. In this sense, having a tool that allows us
to update our assumptions every time they change, producing thus a fresh projection,
is definitively a step forward.
The critical issue
then becomes: how to set goals to measure employees’ performance, and to award
them accordingly if you have replaced the budget by rolling forecasts. Today
those goals are imbedded in the annual budget. But, how to set goals if
everything is constantly changing? One possible
solution is to set shorter cycles and to measure employees’ performance more often,
but this would require a greater administrative effort. Perhaps there is also a
technological solution for this problem. Another
possibility is to look for new Key Performance Indicators (KPI) to measure employees’
performance. Instead of financial indicators try to find a new ones that
measure the real drivers of the business, like number of clients served, or
items sold per square meter instead of annual sales, for example; or try to
find indicators that will remain relevant despite changes in pricing strategy
or the opening or closing of stores.
I should recognize that,
at the moment of writing these lines, I am full of doubts and concerns about
how the replacement of the annual budget by rolling forecasts will affect the entire
annual planning cycle in its broadest sense. Especially, how it will affect the
thorny issue of employee’s incentives. However, I do not hesitate to welcome new
tools to break the long process of annual budgeting in favour of smaller
processes continuously updated. That imposes rethinking the way we do annual
budget, looking for how we can continuously update the premises on which our financial
projections are based, in order to facilitate a better decision-taking process.
It would mean to break the budget mega activity into a number of ongoing routines
of scanning the business environment. Perhaps the annual budget could be, after
all, a snap shot, a photograph taken sometime in the year of the annual
projection we have at that moment, plus some kind of challenging adjustment to
be achieved.
