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66878_CH01 7/31/2000 4:39 PM Page 1

PART ONE

BUDGETING AND
F O R E C A S T I N G OV E RV I E W
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CHAPTER 1

BUDGETING TODAY:
OVERVIEW AND TRENDS

For years, companies have viewed their budgets simply as a mandatory esti-
mate of the upcoming year’s revenues and expenses. However, this attitude is
quickly changing as the marketplace becomes more competitive and organiza-
tions become more dynamic. Successful companies are constantly improving
their ability to accurately predict their future operations and their related
resource requirements. Not only does this heighten the importance of the bud-
geting and planning process, but it also changes the traditional roles of spread-
sheets, legacy budget systems, and software created in-house.
A study by the Institute of Management and Administration shows
how important budgeting and planning is becoming to corporations. (See
Figure 1.1.) Controllers of large and small companies were asked to identify
their most critical job functions, and nearly 59% rated budgeting as their key
job function.
The same study showed that the budgeting process now involves more
activities and individuals throughout the entire organization. In other words,
the days where a few people at corporate headquarters created the budget in
isolation are quickly disappearing: Budgeting has become an organization-
wide activity. When asked how their role as controllers had expanded, the
respondents ranked budgeting/control and strategic planning as the two leading
activities. This further supports the notion that there is a strong trend toward a
more complex budgeting and planning function.

3
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4 BUDGETING TODAY: OVERVIEW AND TRENDS

Number of employees
Combined Less than 250 More than 250
Annual planning and budgeting 58.6% 56.6% 63.3%

Balance sheet management 52.2% 57.8% 48.0%

Monitoring spending 45.2% 50.6% 37.8%
Performance measurement 36.6% 32.5% 40.8%
Internal control 30.6% 26.5% 33.7%

Closing procedures 29.0% 30.1% 28.6%

Long range financial planning 29.0% 28.9% 28.6%

Other 8.1% 6.0% 10.2%

The Controllers Report #1, 1998, The Institute of Management and Administration

FIGURE 1.1 Critical job functions for controllers

Reprinted by permission. © 1998, Tim Harris, Editor, IOMA’s Controller’s Report. (212) 244-0360.
http://www.ioma.com/.

RE-ENGINEERING THE BUDGETING AND FORECASTING

PROCESS
Undoubtedly the expectations from corporate strategic planning have
increased as a result of the changing competitive landscape and the availability
of new technology. But even though companies are now spending more time
than ever creating more detailed and more frequent budgets and forecasts, we
are still in the early stages of advanced corporate planning. Most companies
are still not happy with the planning processes they have in place and the
results they see. Some often cited complaints and concerns are:
• Lack of employee motivation and initiative during the planning process
• Lack of clearly defined strategies to drive planning and forecasting
efforts
• Minimal correlation between corporate strategy and operational plans
• Politics, rather than strategy, influencing the planning process
There is little doubt that every company has room for improvement.
However, the improvements must start within the organizations themselves,
with a re-engineering of the planning process. Unless the organizational issues
are addressed, the planning and budgeting process will not be as effective nor
as useful as it needs to be.
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RE-ENGINEERING THE BUDGETING AND FORECASTING PROCESS 5

A great misconception is that new technology will take care of the cur-
rent problems. Resolving problems with old, inflexible legacy budgeting soft-
ware or out-of-control spreadsheet models often becomes management’s focal
point, rather than changing the company’s planning process. As a result, a large
number of companies go out and purchase one of the many new budgeting and
planning software packages, thinking that it will completely solve their current
challenges. However, in most cases, the problem is that although the new soft-
ware usually replaces the old system and offers additional features and
automation, the underlying organizational problems still remain. Thus the
potential benefits to the company are smaller than if the whole planning
process were revamped.
According to leading management consultants, certain key issues should
be addressed in order to streamline the planning process:
• The amount of planning data should be limited.
• The type of planning data produced should be standardized.
• Data should be shared across the organization, in real time.
• Employee compensation should be tied to strategic plans.
Modern budgeting and forecasting software can help automate and
improve many of these items, but the underlying weaknesses are usually not
software related; they are organizational issues that must be addressed by top
management. To fully realize the benefits of the software, all aspects of the
budgeting process must be examined. When new software is implemented,
maximum gains can be realized if everyone takes this as an opportunity to
improve the entire budget cycle, not just the software used in the cycle. As an
example, the inputs required, the flow of information, and the people involved
should all be reviewed and questioned. (See Figure 1.2.)
Many resources, such as people within your organization, trade and pro-
fessional organizations, and outside consultants are available to help re-engineer
these processes.
As companies continue to redefine their budgeting and forecasting
processes, several key trends have begun to emerge:
• Tighter integration of corporate strategy with budgeting
• Added detail in strategically important areas (such as revenue)
• More complex models
• Improved accuracy of budgets and forecasts
• Integration of available resources and tools
• More frequent revisions (re-forecasts and rolling forecasts)
• Increased employee participation and departmental involvement
• Streamlined budget reviews and approvals
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6 BUDGETING TODAY: OVERVIEW AND TRENDS

Planning &
Target Setting

Decision
Budgeting
Making
Management Vision
& Leadership

Reporting
&
Analysis

FIGURE 1.2 Budgeting and planning process

TIGHTER INTEGRATION OF CORPORATE STRATEGY

WITH BUDGETING

Companies want to tie their budgets to their corporate strategy to make sure that
the projected resource requirements are available to support the anticipated
future of the company. In order to be profitable, a company cannot afford to
have any shortfall between its anticipated revenues and expenses and its plans
for the future. Furthermore, these future plans need to be effectively communi-
cated so that all employees involved in the planning process know and under-
stand the activities that will ultimately lead to better operating results.
In essence, what this means for the budgeting process is that headquarters
must learn how to share strategy with the rest of the organization. For example,
suppose a company has developed an operating plan to increase revenues by 10%
and to decrease specific operating expenses by 5% over the next 24 months. After
these targets have been set at the top level of the organization, they must be com-
municated effectively to all people affected by these targets. This information is
vital so that managers can create budgets that reflect the corporate strategy.
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ADDED DETAIL IN STRATEGICALLY IMPORTANT AREAS 7

Historically, linking corporate strategy with the budget process has not
been successful in most companies. This is due partly to corporate structure
and partly to the technology used within the corporation. Without efficient
inter-departmental communication and technology, it is difficult to link the
two. Using effective budgeting software can help close the gap between strat-
egy and the budget. Implementing a budgeting software package where corpo-
rate targets are visible to the end user and all key budget figures are measured
against specific targets at the point of data entry is one solution.
This break between strategy and budgeting may also be due to a general
lack of focus on the budgeting process itself. Creating the local operating bud-
get was often viewed as a completely separate activity from long-range plan-
ning. Today, however, it is becoming increasingly apparent that the two must
overlap. Long-range budgets created at headquarters that do not agree with the
current operating budgets used at the local level are completely useless. All
plans and future projections at all levels of the organization must be geared
toward the same goals and results.

ADDED DETAIL IN STRATEGICALLY IMPORTANT AREAS

As budgeting increases its importance to companies and accounting and bud-
geting tools become more integrated with increased functionality (including
reporting capabilities), more, rather than less, detail has become the norm.
However, the additional detail is manifested in the areas that drive the bulk of
the business revenue and expenses. The resulting measurements are often
referred to as key performance indicators (KPIs). Several reporting method-
ologies or performance measurement methods have been developed to assist
companies in focusing on their key business drivers in both their planning
processes and in their ongoing reporting. Some of the more recognizable ones
are the balanced scorecard and activity-based budgeting. You can read more
about these in Chapter 4.
Regardless of their reporting methods and level of detail, most compa-
nies today budget for all their profit and loss accounts, sometimes with a dif-
ferent level of detail for different financial items, and for key statistical items
such as headcount or sales volume. Newer budgeting systems also allow for
line item detail with text comments even at the most detailed level (many line
managers do their line item detail calculations in a local spreadsheet). This
simply means, for example, that an account such as 5670-Travel could be
opened in a screen where the user can enter as many subentries as needed in
order to come up with the total for the account. The strategic implications of
this can be very important.
It is now possible for top management to focus on important business
drivers and then drill down to the line item detail for any item. As a result, they
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8 BUDGETING TODAY: OVERVIEW AND TRENDS

can spend more of their time analyzing and taking action on the items that rep-
resent the most problems or opportunities (such as salary expense or revenue),
and less time on items that are fairly static from year to year (such as rent).

Multi-dimensional Budgeting

In order to produce measurements for the key business drivers discussed

above, companies now have to integrate multi-dimensional data from many of
their business applications (such as the sales order entry system or human
resource system) with their budgeting application. Bill Gates, former CEO of
Microsoft Corporation, says “anyone who has participated in a budget review
with the executive committee at Microsoft knows that we insist on having
accurate numbers and insightful analysis of those numbers. Numbers give you
the factual basis for the directions in which you take your products.”1 This
means that with better integration between core accounting modules and with
more focus on key performance indicators, line managers, as they sit down and
attempt to enter their best vision of the future, will have access to much more
historical transaction detail for these key items than ever before. (See Figure 1.3.)

Product A March Mar

Product B February

Product C January

Gross Margin
REVENUE
Cost of Sales

Division Z Actual
Northeast
Division Y Budget

Southeast
Division X Forecast

Northwest

Southwest

FIGURE 1.3 Information integration

1Bill Gates, Business at the Speed of Thought (New York: Warner Books, 1999), p. 214.
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MORE COMPLEX MODELS 9

This also gives management a possibility to compare actual figures with

budgets in the key operational areas of the business complete with important
details, for example, sales per product per market per customer. Or it can mean
that management can look at a profit and loss report for an entire department in
one instance, and look at the profitability of all the projects undertaken by that
department at the same time.

MORE COMPLEX MODELS

Another important trend in budgeting is the increasing complexity of budget-

ing and forecasting models. Although there is also a trend toward focusing on
fewer budgeting items, those items that are closely examined are split into
more detail than ever. New measurements of business performance are con-
stantly being invented, and many of them demand source numbers that have
not traditionally been part of the budgeting process, for example, revenue per
square foot, customer satisfaction, and so on.
Frequent acquisitions and divestitures also represent challenges. It seems
like corporations are getting ever more dynamic as they scramble for market
share and positioning in a competitive marketplace. A majority of all organiza-
tions today are still using spreadsheets to distribute, collect, consolidate, and
report budgets and forecasts. For small, stable companies with few depart-
ments and product lines or services, the spreadsheet is one of the best tools ever
to support the budgeting process. However, mid-sized and larger companies
face many challenges that make their spreadsheet budgeting models rather
complex and hard to maintain. Some of these challenges are:

• Multiple acquisitions or divestitures per year

• Many products and services
• Large number of departments, divisions, subsidiaries
• Large number projects
• Large number of front-end systems to interface with the budgeting
model
• Budgeting for subsidiaries and/or sales in foreign currencies and high-
inflation countries

As companies are discovering the value of accurate, focused and detailed

budgets as key strategic tools to their decision making, these business factors
listed above represent challenges for their planning models. As a result, busi-
nesses now demand better budgeting and forecasting functionality from their
software vendors (see Chapter 6 for more detail on budgeting software).
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10 BUDGETING TODAY: OVERVIEW AND TRENDS

IMPROVED ACCURACY OF BUDGETS AND FORECASTS

If your budgets and forecasts are always far off the actual results for the period,
there is an evident danger that:
• Bad decisions will be based on incorrect projections of the future.
• Management will pay less attention to budgets because they do not trust
the numbers.
• The organization as a whole will suffer from lack of proper planning.
Poor accuracy of budgets has been and still is a problem for many com-
panies. With the marketplace more competitive than ever, organizations are
realizing the necessity of accurate numbers and forecasts.
Some budgets are not accurate because:
• They are derived from poor budgeting tools (e.g., spreadsheets with for-
mula errors).
• Employees are allowed too little time to create good projections.
• Employees lack motivation (e.g., they ignore seasonal trends while bud-
geting revenues or expenses).
• Employees lack training (e.g., a new line manager might not know the
business well enough to create an accurate budget).
• Key employees are not involved in the budget process (e.g., many com-
panies have a very top-down oriented budgeting process where most or
all budget figures are created by top management, with little involvement
from line managers).
Improving the accuracy of budgets and forecasts will obviously make it
easier for management to plan and execute a large number of operating activi-
ties in their company. Such activities include sustaining appropriate staffing
levels, purchasing raw materials and supplies, maintaining inventory levels,
properly adjusting employee incentive plans, and more. Just imagine the
advantages over the competition if a company had accurate projections of how
much they were going to earn and spend in the next year or two, which in turn
would determine what cash flows they could expect, how many people they
would need to hire, and in which markets they should focus their energy. Com-
panies are now realizing how beneficial this information can be to them and are
attempting to improve the accuracy of their budgets and forecasts by increas-
ing employee involvement, investing in better budgeting tools, and so forth.

INTEGRATION OF AVAILABLE RESOURCES AND TOOLS

Larger and mid-sized companies, in particular, have many integration chal-

lenges in the budgeting process. On one side you have the integration of dif-
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INTEGRATION OF AVAILABLE RESOURCES AND TOOLS 11

ferent planning processes that exist in different organizational entities, and on

the other side you have the physical integration of different software.

Integration of the organization’s planning processes

A natural result of different operational units being involved in different

activities (e.g. manufacturing vs. sales) is that they employ unique planning
processes. (See Figure 1.4.) In addition, many corporations are frequently
acquiring new companies, with completely different budgeting cultures and
processes. However, for top management to come up with a corporate strategy
and set specific and intelligent targets for the future, there is a need for good
communication both from the top down and from the bottom up. Thus, with the
surge in interest in budgeting and planning, companies should be spending
more time on improving their internal communication processes and stream-
lining their different planning processes and the integration between them.

- Set strategic targets

- Analyze reports

ABC
Corporation

Manufacturing Sales Accounting

- Improve efficiency - Increase revenues - Control expenses

- Increase quality - Grow market share - Financial reporting

FIGURE 1.4 Planning integration

Integration of the organization’s software

Typically, different planning processes also have meant the existence of

local spreadsheet models that feed into a higher-level corporate budget model,
or that companies have programmed their own budgeting software to handle
their different divisions’ planning. (See Figure 1.5.) Needless to say, this often
results in delayed reporting, poor integration possibilities, double data entry,
and lack of integrity in the overall budget.
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12 BUDGETING TODAY: OVERVIEW AND TRENDS

OLAP/
ROLAP Spread-
Software sheets

Budgeting
Solution

Sales Order
Entry General Fixed Payroll
Software Ledger Assets

FIGURE 1. 5 Software integration

MORE FREQUENT REVISIONS

Nowadays, companies typically create an annual budget, and then revise this
several times during the year (these revisions usually are called forecasts).
Recently, a number of companies have dropped their extensive, annual budget-
ing process and instead have begun to rely on continuous forecasts, called
rolling forecasts. Many companies prepare these forecasts on a quarterly basis,
and they project for 12 to 24 months ahead.
Companies also distinguish between a short-term plan and a long-term
plan. Due to a lack of reliable information and changing circumstances, the lat-
ter is always at a high level, and often it is completed solely by top manage-
ment. The recent trend for short-term plans has been to revise them more
frequently than the once-a-year budgeting ritual that was once the standard.
Monthly or even bi-monthly revisions are becoming normal.
Also, it is important to distinguish between companies who simply
revise their original budget until they reach the end of the year, and those that
use the continuous rolling forecast discussed previously. The second is no
doubt the best management tool, because it gives a continuously updated pic-
ture of a specific time in the future, which management can utilize in their deci-
sion making. However, because the planning becomes a monthly process, the
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INCREASED EMPLOYEE PARTICIPATION AND INVOLVEMENT 13

people involved must be disciplined and the technology used should automate
and simplify the data entry and reporting processes.

INCREASED EMPLOYEE PARTICIPATION AND DEPARTMENTAL

INVOLVEMENT

Companies that have maintained a central budgeting process, essentially han-

dled by the budgeting manager, usually have managed to avoid the many pains
and delays that come with involving the whole organization in the planning
process. However, these companies also have found that it can be hard to moti-
vate employees to reduce expenses, increase revenues, and so on, when they
have not had a say in allocating funds in the first place.
Another major disadvantage of a centralized budgeting process is that a
tremendous amount of knowledge is hidden in the “trenches” of a company.
Line managers know the day-to-day facts of their operational area, and most
likely, they are the best people in the company to supply good budget numbers.
For example, a sales manager is much closer to the action in the field than the
corporate budget manager, and if there are some unexpected deals or trends on
the horizon, these are not likely to be reflected in the budget or forecast unless
the sales manager is involved.
Because of new technology, it is now easier than ever to involve employ-
ees at all levels in the budgeting process. Using modern web-enabled budget-
ing applications, you can easily communicate corporate strategy and financial
targets to employees, and they can enter local budget figures with text com-
ments that roll up to a corporate total. The employees only need access to a
workstation that is linked to the Internet or Intranet and that has a web-browser
such as Microsoft’s Internet Explorer or Netscape (this is free software). (See
Figure 1.6.)
The whole budgeting application and database resides on one central
server, and there is no need to install or maintain the software in other places.
Further on, a high level of security and simple budget screens allow a large
number of employees at different levels in the organization to contribute their
estimates with minimal need for training and supervision.
With the use of web technology it is also possible to involve people not
directly connected to your organization, such as a reseller channel, in the bud-
geting process. With very simple instructions, they can log on to your web site
with a password and provide you with their estimated sales for a specific future
period. Because all the numbers go directly to a central server, they are avail-
able immediately for analysis by top management.
The ultimate goal for many companies that involve their whole organi-
zation in the planning process is to use their employees’ knowledge to boost
corporate performance. This will happen through improved accuracy of the
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14 BUDGETING TODAY: OVERVIEW AND TRENDS

HQ

Reports
&
Analysis

Reports Reports
& &
Analysis Web-based Analysis
Div.A Div.B
budgeting
Solution

Reports
& Budget
Analysis data entry

Manufacturing Purchasing Marketing Sales

FIGURE 1.6 Web-based budgeting

company’s numbers, increased employee understanding of why the budget fig-

ures are what they are, and by increasing each employee’s motivation to
achieve those numbers.

STREAMLINED BUDGET REVIEWS AND APPROVALS

Who does not want to streamline their budgeting process? When can you sit
down and say that your budgeting process has reached an optimum level?
Probably not for a while, because modern budgeting and forecasting are still
being discovered, learned, and implemented in most organizations. That is why
budget managers everywhere say that one of their primary goals is to stream-
line their company’s budgeting process.
There are many things to improve before the whole planning cycle is
fast, frequent, accurate, and smooth. Improvements are needed both on the
technology side and the human side:
• Existing operational data, competitive information, and economic data
must be available to top management in an understandable format, so
they can set realistic strategic targets for the organization.
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STREAMLINED BUDGET REVIEWS AND APPROVALS 15

• Strategies and strategic targets must be developed by senior management

and told to managers so that they can create budgets that realistically
support the corporate strategy (Figure 1.7(a)) rather than just having
managers create budgets without any guidance (Figure 1.7(b)).
• The budgeting software must be flexible enough to support all key bud-
geting initiatives, such as communicating strategies and strategic targets
down through the organization, as well as giving line managers local
power to create their budgets and send them back again with supporting
schedules and comments. It must also be able to give management con-
solidated and detailed reports as well as exception reports.

6. Final Budget

1. Senior management
sets strategic targets

5. Budget
Submission

2. Division managers
cascade targets

4. Budget
Submission

3. Department heads
enter budget

FIGURE 1. 7A Top-down bottom-up budgeting

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16 BUDGETING TODAY: OVERVIEW AND TRENDS

6. Final Budget

1. Senior management
reviews budget

4. Request for
changes

2. Division managers
review budget

5. Request for
changes

3. Department heads
enter budget

FIGURE 1. 7B Bottom-up budgeting process

• A full budgeting cycle should take a few weeks (not months!) to com-
plete. Periodical revisions to a budget (forecasts) should take only a few
days.
Streamlining the budgeting process requires all the trends discussed in
this chapter, and it can dramatically improve your company’s long-term per-
formance and competitiveness. A frequently updated budget that is the result of
the collective knowledge and intelligence in your organization, and that uti-
lizes modern technology and software to automate the reporting process
should be your company’s ultimate goal.