The more enlightened amongst you may have picked up murmurings that annual budgeting has become an increasingly discredited activity: rolling 12 or 15 month forecasting is the way to go. For those of you who have not woken up to this revelation, here are 10 reasons why annual budgeting is a waste of time.
- There is confusion about what a budget actually is. Is it a target? Is it a forecast? Is it a way of allocating resources? It ends up being a hotch-potch of all three, obscuring desire, responsibility and reality: A target is what you want to happen; a forecast is what you think will happen; resource allocation is a decision-making process that should be undertaken at the point when resources need to be allocated, not an arbitrary date in the calendar.
- The beautifully balanced annual budget gives a false sense of control. It is an illusion based on guesswork and political chicanery. Measuring actual progress against relative measures such as prior year results, or, if available, comparable industrial benchmarks is a much more productive use of people’s time.
- Annual budgets are out-of-date before the year begins. Businesses gain little value from comparing themselves to a view of the world that is based on assumptions that are at least 3 months old before the year has even begun.
- Budgeting processes tie up huge amounts of management time – often in re-working assumptions that have been under-mined by events during the lengthy budgeting process. This effort would be much better deployed in carrying out up-to-date and regular forecasting and market analysis.
- Annual budgeting encourages unhelpful behavior amongst management teams, where defending your budget internally rather than optimizing performance compared to the competition, is seen as the winning strategy.
- Talking of strategy, annual budgeting often links very poorly to the business planning process, particularly in bigger businesses. Being someone who has spent a lot of team in smaller, growing businesses, it strikes me as amazing that a budget can exist separately to the plan that it is meant to represent, but I have seen and heard about it from too many people to disbelieve in the standalone (& meaningless) annual budget.
- Annual budgeting reinforces a view of the business that works to the decreasing time horizon of the end of the budget year. The world does not end at the end of the financial year – only your budget does. So stop using it and start looking 12 months ahead wherever you are in the calendar.
- Submission of annual budgets to be approved or allocated from a corporate centre encourages top-down centralized decision-making that is remote from what is going on in the business. This communication process means decision-making is slow and stops managers from taking responsibility for their actions. Remember what happened to state-controlled communist economies?
- Annual budgeting is always too detailed, encouraging micro-management of budget expenditure lines rather than overall bottom line financial outcomes.
- If go/no go decisions are largely made at the time of the annual budget, opportunities will be missed to start and stop value-adding activities according to outside events.
A focus on regular forecasting where management are encouraged to be realistic about how things really are, will dispel much of the wasted effort and muddled thinking that stems from annual budgeting.
Just in case you think I am totally down on budgeting it does have some uses, which I will reveal in my next missive.
Bellevue Partners can help you improve your forecasting, budgeting and the productivity of your finance function. Get in touch if you would like an exploratory conversation to find out how we could help you.