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Making the Budget Process Effective

For many of us in the Finance world, “budget season” is a meaningless measurement of time because we always seem to be in the middle of working on The Budget. Whether we’re looking at capital requirements for the next one, three, five, or even ten years out, planning head counts, or building pro formas, finance professionals spend a considerable amount of time planning for the future. Unfortunately, our prognostications rarely hold true. As actor-director-writer extraordinaire Woody Allen once said “if you want to make God laugh, tell him your plans.” With all the time spent on planning and sharpening the pencil just to miss the mark, why do we even bother with budgeting? 
As always, the reality is clouded in shades of grey. No business can truly operate for long without some semblance of a plan. Try taking your latest app idea to the angels of Silicon Valley promising your potential investors that they’ll get their money back “eventually”. Ultimately, we’re forced to admit that planning, in some shape or form is a necessary evil. 

So, how can we make it more effective?
I propose that it’s time we start to look at budgets as a playbook for how to operate our business over the coming year. Where many organizations set aspirational goals and impose those down on the operations teams to achieve and exceed, we should be looking at the budget as a guide on what the company can achieve given any possible scenario. If you’re in logistics and a major hurricane threatens the Gulf Coast, how will you get your client’s cargo to it’s final destination. And what will you do if 60% of the country’s oil refineries are offline and you cannot get fuel or your fuel prices surge? That one disaster has multiple impacts to your grand plan.
How can an organization plan its budget around multiple scenarios without turning the budget season into a budget year?
1.) Drivers-Based Budgeting - a budget should be based on some set of drivers. A driver-based budget is easily updated, and because it’s easily updated, multiple scenarios can be run in relatively short order. For instance, if you set your sales budget based on units sold and average price per unit, you can easily change either of those variables and create a new sales budget in a matter of minutes. Going back to the earlier example of escalating fuel costs, if you know, roughly, how many miles your trucks drive on an annual basis and what your average fuel economy looks like, then you can easily research historical fuel price trends and run sensitivities on high fuel prices and low fuel prices. Almost instantly, management can get an idea of the impact of a major risk on the operation and work on contingency plans.
2.) Partner-up. Bring operations into the budget discussion and allow them opine on budget targets. This isn’t to say that managers, who may be compensated in part on their ability to meet or exceed budget, should set their own budgets. However, Finance should listen to the operations team to understand what kinds of risks and opportunities may exist in the operation, and Finance can assign values to those risks and opportunities. Going back to the first point, using a drivers-based model, Finance can apply a single risk item to the model and generate a new pro forma for management. Sometimes, a risk isn’t worth mitigating or thinking too much about, and sometimes exploiting an opportunity requires making changes which have negative ramifications to the qualitative aspects of the business (e.g. guest satisfaction, investor perception, etc.).
3.) Draw a line in the sand. As a team, decide what is important for the organization and build your plans around those virtues. If you want to grow revenues, develop some key assumptions and plans around how to achieve that growth and then end the discussions. You cannot have the perfect plan, but you can get 80% of the way there. I have been a part of some organizations that continuously drag out planning to the point where budget truly is a full-year exercise. If you spend the whole year planning, it leaves no time to execute. Will there be major changes to the underlying assumptions between planning and execution? Maybe, but the point I’m trying to make is that you need to set a baseline and then develop some base contingency plans based on a few possible scenarios.
4.) Execute and adjust. In line with #3 above, set the financial objectives of the company, assess the risks and opportunities, and then execute as planned. As the year unfolds, evaluate progress against the business objectives. I recommend reviewing progress quarterly for two reasons: a.) because it takes time to ramp up execution on plans, and b.) it gives the organization enough time to evaluate and adapt to where it is on the range of expected results. If the company is on the low-end of projections, management can decide if there are external factors (e.g. poor economy, high producer costs) or internal factors (e.g. ineffective training, ill-conceived logistics) affecting execution and pull out the contingency playbook developed during budget season.
I am not suggesting that we don’t push our organizations to achieve a little bit more than they have in the past, but rather, let’s use the budget to recalibrate objectives and goals and determine what the company can really achieve.
What are your thoughts on the budget process? Does your organization utilize the budget to plan out execution, or is your budget process simply a target setting exercise? What have been some effective budgeting techniques you’ve utilized in the past?

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