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BROKEN BUDGETS?
BY RENITA WOLF
June 1, 2015

24 3 COMMENTS

The traditional annual budgeting and planning process is broken and full
of flaws. It’s too complex, includes assumptions that often turn out to be
wrong, and doesn’t respond well to a volatile and competitive world. It’s
stressful for company leaders who have to endure endless budget iterations,
debate over conflicting business goals, and sandbagging, all of which lead to
poor decision making. The result is a final product that becomes less
relevant with each passing month.

A PRESSING NEED FOR MAJOR RENOVATION

What’s needed is a new approach to planning, budgeting, and forecasting (PB&F)—one
that transforms it into a powerful tool for executing your business strategy and
informing company leaders, leading to better business decisions. The new approach to
PB&F should be faster and more agile, with explicit evaluation and analysis of variability
built into the planning and forecasting process through the use of technology. An
innovative, fleet-footed process will enable companies to be sensitive to changes at the
margin, in consumer spending patterns, in gross domestic product (GDP) growth rate, in
foreign exchange rates, and in other important value drivers.

In an April 2013 report, “Planning, Budgeting and Forecasting,” KPMG stated that “60–80
percent of firms fail to execute their strategies, and fewer than five percent of employees
are aware of, or understand, their firms’ strategies.” Clearly, renovating PB&F practices
presents an excellent opportunity to build business value.

EVALUATING PB&F

Management accountants and other financial professionals obviously know all the
details of PB&F. Planning determines how a company will align resources with strategy
and how it will measure progress. The role of budgeting is to determine where resources
should be deployed and to make certain that people are aligned to deliver the company’s
strategy through an integrated plan. The budget maps out how the company will ensure
accountability and encourage behaviors needed to execute the strategy. Forecasting,
meanwhile, determines how the company will adjust to changing conditions. Its role is
to review performance and, if necessary, outline actions to get back on track to ensure
targets are met.

Here’s where you come in. Finance leaders are focused on creating value. You’re the
voice of reason, cool in the heat of battle and skeptical in the face of exuberance. This
puts you in an excellent position to create business value by building top-quality PB&F
practices. When it comes to planning, budgeting, and forecasting, you make the rules. In
fact, in a recent Hackett Group study, CFOs identified planning and performance
management processes as the number-one process area slated for transformation in
2015. (See Figure 1.)
Many experts believe the traditional bottom-up approach to planning, where historical
performance supports the plan, is likely to destroy value in organizations. A better-
focused process can be implemented so that the annual budget is used as a tool to
optimize resource allocation and align people to achieve the organization’s strategic
goals. Spending less time creating the numbers allows for more time analyzing them and
driving action that generates tangible results.

Organizations must plan to be successful; it doesn’t happen by accident. The planning

process is an opportunity to get everyone on the same page and to understand the
organization’s view for the future. It’s up to you to create a new planning approach that
leads to increased transparency, trust, and accountability to move things forward.

Now’s the time to evaluate practices that are working or not working. Retain the ones
that are, eliminate those that aren’t, and add new best practices where needed.

SET THE FOUNDATION WITH STRATEGY

A good strategic plan should focus on what’s critical to achieving success. It should
provide answers to simple yet key questions—as Albert Einstein said, “…as simple as
possible, but not simpler.” Strategy answers important questions, including: What
businesses are we in? How will we compete? Which choices will make us more money?

Successful companies set the foundation for an effective planning process that begins
with strategy. Your company’s strategic plan creates a shared vision of what’s important
to the organization and translates it into a simple story about its future.

In a McKinsey Global Survey of more than 2,000 global executives, only one-third
agreed that their corporate strategy approach represented “a distinct exercise that
specifically addresses corporate-level strategy, portfolio composition issues.”

Increasing the time spent on strategy and involving more senior leaders in strategic
dialogue makes it easier to stay ahead of emerging opportunities, respond quickly to
unexpected threats, and make timely decisions. An integrated PB&F framework links
top-down, strategic targets to financial and operational bottom-up forecasts. (See Key
Questions About Your Strategic Plan.)
DESIGN YOUR PLANNING BLUEPRINT

An effective planning process begins with a blueprint that includes thoughtful choices
around resource allocation, the planning horizon, management accountability and
participation, transparency, internal communication tools, the level of detail to include,
and, perhaps most important, how to adjust to changing conditions.

Resource Allocation. Resources should be aligned with strategy and coordinated across
the organization. This is the time to evaluate internal projects to determine those
opportunities with the greatest potential return on investment.

Planning Horizon. Select the planning horizon that best fits your business processes,
such as manufacturing, sales, and payment cycles. The length of time depends on the
operating model and must be tailored to the decisions you need to make. You should
plan out only as far as you can see or as far as your decisions require. The typical
planning horizon is a 12- or 24-month plan or rolling forecast. Axiom EPM’s September
2013 survey of 244 enterprise organizations, “5 Components of Accurate Rolling
Forecasts,” revealed that half the companies said their horizon for forecasting is the
current fiscal year. (See Figure 2.)

Management Accountability and Participation. Identify the roles and responsibilities for
individuals included in the PB&F process. Determine how best to measure progress and
to align financial targets and rewards. Establish incentives that drive the correct
behaviors by clearly articulating accountabilities that link the plan to each individual’s
performance. The goal is to encourage behaviors needed to execute the strategy. This
leads to less sandbagging and gaming.

Transparency. Be intentional about adding transparency to the planning process.

Transparency enables you to achieve greater trust, coordination, and cooperation across
the different functions within the organization. It can also help reduce the tendency for
managers to sandbag.

Internal Communication Tools. Select communication tools and channels that include all
stakeholders in the process. The communication approach should define the purpose of
the budgeting and forecasting process, focused on cascading and enabling strategy with
incentives that drive the right behaviors across the business. Forward-thinking
organizations are developing interactive visualization of data to communicate their
strategies. Two excellent examples of this are the 2006 TED Talk video, “Hans Rosling:
The best stats you’ve ever seen,” and Kiva.org’s Intercontinental Ballistic Microfinance
visualization of loan funding and repayment flows.

Level of Detail. Produce as little or as much detail as needed to make smart business
decisions. Focus on the questions that need to be answered. More detail doesn’t mean
better decisions; in fact, too much detail can reach the point of diminishing returns,
where the cost of knowing may increase and the value of knowing may decrease. Begin
by focusing on the questions that need to be answered, such as where you’re headed and
how you’ll get there.

Focus on and only plan line items that really matter. Don’t populate every number from
scratch. Instead, prepopulate as much of the data as you can for 80% to 90% of the line
items. To get a baseline, build in algorithms that will take your current trend data in each
area and project that out for the year.

Adjust to Changing Conditions. Your planning process must be dynamic to respond to

changes in the industry, the economy, the competition, key commodities, and other
assumptions. A dynamic plan enables the organization to adapt and grow to meet
changing market conditions.

Analytic tools and predictive models do a great job of allowing organizations to adjust to
changing conditions. They require fewer inputs than traditional planning and help
automate and shorten the annual budget cycle. Analytic tools incorporated into the PB&F
process enable the finance department to generate scenarios needed to question old
assumptions and to stimulate new thinking by churning through internal and external
data. Analytic tools challenge the idea that professional experience and intuition are
reliable substitutes for fact-based decision making—it takes all three.

Predictive models enable organizations to focus on leading vs. lagging indicators and
provide much greater insight into what’s happening in the organization. In addition, they
allow planners to evaluate alternative scenarios based on fluctuations in factors that
influence financial outcomes.

Predictive models should be designed and implemented using a driver-based planning

model, which Deloitte defines as “an approach that bases financial forecasts on
operational drivers.” The models should incorporate critical operational data or drivers
that influence financial outcomes. Over time, they increase the predictive accuracy of
plans. Driver-based planning isn’t purely financial in nature; the model captures the
interdependencies of the business and provides a better-rounded picture of its future.
(See Key Benefits of Driver-Based Planning.)

Owned by business managers to drive the focus across the organization, clearly defined
value drivers measure progress against targets that are linked to the organizational
strategy. They include market share, service and products (existing, new, and a mix of
both), customer channels (segments, service), and market growth (contract life cycle).

A tip: If you’re new to designing predictive models, start small! Use model-based
forecasting to support target setting, and build your experience using data to create
meaningful scenarios.
In the end, when it comes to designing your planning blueprint, determine what works
best for your company and confirm with stakeholders. Retain practices that add value
and toss the rest.

THE BUILDING BLOCKS

Once your organization has a planning blueprint in place, data, dashboards and
scorecards, technology, and change management become the building blocks that
support valuable planning, budgeting, and forecasting practices. The execution of
business strategy is often hampered by a lack of reliable information. In its April 2013
report on PB&F practices, KPMG determined that “seven out of ten executives do not get
the right information to make business decisions.”

Data. Data provides a common business language, a set of definitions, and agreed-upon
standards. Data organized through the use of data models ranging from corporate to
individual systems should adhere to a common set of standards. A system of controls and
governance should be in place to ensure the quality, consistency, and completeness of
information, resulting in data that is consistent wherever applicable across multiple
business units.

Dashboards and Scorecards. A dashboard measurement system provides a simple, clear

message about your company’s strategy that all employees can understand and
internalize in their everyday operations. An efficient system includes automated
dashboards and scorecards. Alerts and early warnings are built into the system by setting
limits so that material variances get flagged when the limit is reached. This eliminates
the need for someone to sit down and sift through a monthly report that has 200
variances and try to determine which ones are important. Company leaders can then
agree on the most important measures.

A well-constructed dashboard provides the road map for achieving the company’s
strategy. It decompresses high-level stretch targets into ambitious targets for the linked
objective and measures on the dashboard. The organization can then define the strategic
initiatives designed to close the planning gap between the stretch targets and the
organization’s current performance. In this way, the knowledge, tools, and means are
provided to achieve the stretch targets. Employees are then more willing to sign up for
these targets because they can see the linkages, integration, and initiatives that make it
possible to achieve them.

The most important criterion for initiating the dashboard? Employees should have a
senior leader whose management style encourages communication, participation,
initiative, and innovation.

Technology. Business intelligence platforms offer increasingly powerful analytic tools

that provide access to the right information at the right time. These user-friendly
applications can take large volumes of data, consolidate it, and make it available in near
real-time to business managers to support the planning process. Operations and
financial data are integrated to allow you to prepare a detailed budget and to run
scenarios needed to adapt to the volatile business environment with speed and
confidence. Business intelligence platforms include a workflow to manage the process,
to enable collaboration across the organization, and to store past plans.

But the technology solution isn’t delivered by a stand-alone piece of software. Instead,
it’s often composed of multiple software applications that extract and “cleanse” data
from numerous legacy systems. There are a number of planning and performance
management systems on the market, many of them cloud-based and suited for both
large and smaller companies. When selecting a system for your company, make sure first
that the organization agrees on what it needs to know. An effective business intelligence
platform will provide a unified and trusted view of the business that engages employees
and aligns the organization’s strategy to its execution.

Cloud-based tools are leveling the playing field for smaller companies to deploy
sophisticated functionality quickly and at relatively low cost. Cloud-based planning
systems include communication and collaboration tools and mobile and analytic
applications. All these tools help companies better adapt to an increasingly volatile and
global marketplace.

Change Management. Good process redesign and supporting governance won’t deliver
the anticipated benefits unless employees are on board and support it. Change
management can unlock the value of PB&F and overcome resistance to new ways of
working. A change of mind-set is needed to properly establish and sustain new
processes through communication, education, people management, and strong
leadership. Strategic and economic benefits must be converted into straightforward
behavioral examples of how people will be expected to operate in the new environment.

PLANNING ALTERNATIVES

During the recession, many carefully prepared budgets collapsed because of volatile
stock markets, commodity prices, and exchange rates. As a result, some companies are
abandoning traditional budgets in favor of zero-based budgets or rolling forecasts.

Zero-based Budgets. In today’s rocky business environment—with increasing pressure to

improve productivity while continuing to reduce costs—companies don’t have several
years for their traditional budget process to identify and adjust the resources required to
build company value. For this reason, many organizations are taking a new look at zero-
based budgeting, a method in which all expenses must be justified for each new period.
This can lower costs by avoiding blanket increases or decreases in a prior period’s
budget. For instance, in a 2014 study, McKinsey estimated that, when properly
implemented, zero-based budgeting can reduce sales, general, and administrative costs
by 10% to 25%, often within as little as six months. (See Five Realities about Zero-Based
Budgeting.)
Zero-based budgeting favors areas that bring in direct revenues, such as production and
services, because their contributions are measured more easily than those of
departments such as the administrative or accounting functions. Successful zero-based
budgeting that includes a controlled method to facilitate cost visibility, cost governance,
cost accountability, and aligned incentives leads to a culture of cost management
throughout the organization. It’s the same approach that finance leaders should take
with any other organizational transformation efforts. Begin with aligning the general and
administrative function with the corporate strategy; determine a target or future-state
cost structure based on benchmarks and judgment; evaluate the current state beginning
with an inventory of all activities, processes, deliverables, and the like; determine gaps
between the future state and the current state; build the organization around the future
state; and draw up a road map for implementation.

Rolling Forecasts. Rolling forecasts can improve accuracy and optimize decisions. A May
2013 report from the Aberdeen Group, “Rolling Forecasts Enable Accuracy and Agile
Business Planning,” revealed that “71 percent of top-performing organizations mitigate
risks related to volatile business conditions by continuously updating forecasts to better
reflect current business conditions.” (See Figure 3.)
Rolling forecasts, which typically cover a 12- or 18-month horizon and integrate sales,
operations, and finance, are used to lessen risk, identify new opportunities, and
maximize the use of high-returning investments. Rolling forecasts enable a consistent,
accurate, forward-looking financial outlook despite volatility and provide the ability to
model and execute course correction throughout the year.

LOOKING AHEAD

It’s no secret that the annual budgeting process isn’t creating business value at most
companies. In fact, the traditional bottom-up approach to planning is likely to destroy
value in companies. The PB&F process is in need of a major renovation, and management
accountants and other financial professionals are extremely well positioned to create
business value by building top-quality PB&F practices. Like it or not, finance leaders
need to take a new approach to remain relevant.

In your own organization, you must determine what’s working and what isn’t and
eliminate obsolete PB&F practices. Then carefully rebuild by identifying the practices
that add value. Set the foundation by clarifying your company’s business strategy, align
resources using targets and rewards to increase accountability and transparency, and
incorporate tools that allow your company to identify and respond quickly to changing
conditions.
 Renita Wolf is a Colorado-based financial executive who works
with businesses to define and implement business growth and
operational improvement strategies. She has global experience in
financial management, strategic planning, operations, mergers and
acquisitions, organization restructuring, and technology
implementation. You can reach her at (719) 367-4136 or
rdwolf1@attglobal.net.

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