Planning the Budget
Budget are never easy and you may be thinking: “this year will be harder than ever, as we are so uncertain of what will happen in the next 12-days, let alone next 12-months”.
How relevant is the data from 2020, how contrasting will 2021 be? Will either of these years be a reflection of the future? In fact the only thing harder than this years budget will be the next one!
However, if we step back for a moment, when were we ever certain of what would happen? Did we just go through the motions of a budget process, as a tick-box-exercise? Has this years disruption just exposed a weak budget process that what never really fit for purpose?
This uncertainty is an opportunity to change, reset and start doing things differently, a time to start getting the budget right:
- Act as both a Plan and Control to guide decision making.
- Creating accountability around key assumptions with the right supporting metrics.
- Build a robust governance structure, with change control, data checkpoints and handovers
Why have a budget? What is its purpose?
A budget is more than a forecast: A forecast is a prediction of what may happen
A budget isn’t the strategy: A strategy is long-term overall aim.
A budget is a commitment to a forecast to make an agreed strategic outcome happen.
The purpose of a budget is to plan, organize, track, and improve your financial situation. Controlling your spending to balance saving and investing. budget helps you stay on course in pursuit of your long-term financial goals
Our Standards Benchmarking describes: Planning the budget, as cross functional alignment:
Influence and support the budget creation and reforecasts, by modelling capacity and planning operational budgets and engaging the right stakeholders across the business. Ensure the correct inputs and assumptions are included, reviewed and understood and the necessary action are identified and agreed.
For something so important you would expect this to be a something that we are all taught how to do with ongoing training, and not something we would just learn from the person who used to do it.
If you were to line your stakeholders up and ask them:
- Who has been trained on how to budget?
- What alternative methods could work?
If you were to ask you key stakeholders what the purpose of your budget is, would you get the same reply?
Is it a plan, is it a control? How does this differ from the operating plan? What are your budget responsibilities?
Would these be aligned?
Should we use the budget, or operate within and always under?
Is the budget being used for borrowing money?
Is the budget being used for motivating performance?
Has there been a stretch built in, or is this a realistic budget?
Is this a fixed or flexible budget?
SO many questions, clarity is required to describe what it is and isn’t.
Today, I’m going to take a look at some key budget choices, starting with:
- The initiation, the participation and implementation
- How often this reviewed and how this is linked to strategic planning
- For the accompanying article I will also include:
- The motivation, is this fixed, flexible and does this drive bonuses
- And finally how this is evaluated and performance managed
Here are 4 examples of different budget methods:
- Incremental Budgeting: for example, last year +10% sales -10% headcount! Common method as its easy to explain. An appropriate method where primary cost drivers don’t change.
- Activity-based budgeting (top-down): Based on key assumptions to support targets or outputs, e.g. £ X million in revenue, Y million customers, across multiple-channels, sales & service. Makes it known what needs to be done by each function to achieve targets.
- Value proposition budgeting: a method to make sure that everything included in the budget delivers value for the busines, with the aim of avoiding unnecessary expenditures. If the value is unknown or not strong enough this team or function will be removed.
- Zero-based budgeting (bottom-up): start with nothing, then build-up justifying each expense. A common approach by department managers, as they apply their judgment and experience to calculate how much cost they need to deliver expected performance.
In addition to these typical methods there will be different levels of involvement, which will impact the culture of the business, along with the buy-in and engagement, understanding and accountability.
An Imposed budget, where a top down approach has been set and everyone else must get on with it. This can work as it may be the reality, however this often leads to a disconnect between targets and operational practices (We haven’t got enough people) and a lack of engagement and buy-in.
If this is your chosen method and type of budget make sure you set the expectation “That this is reality and we must just get on with it”, don’t waste time moaning about the method and how targets can’t be achieved. Spend time on understanding the “gap” between budget and reality, what can be done differently, or stopped to help achieve both budget and strategic objectives.
Under these circumstances it can be easy to ignore the value of investment in new technology, or processes and instead try to deliver more with less.
Participative budget, where a bottom up approach drives recommended targets for activity and costs.
These are 2 really important perspectives, that are healthy to do regularly. However it is not uncommon, when doing this to over estimate the value proposition and/or the cost the achieve targets. Using broad assumptions can as easily over-calculate costs and people requirements, as large amounts become every sensitive to changes, e.g. how much does 1% shrinkage cost you (we’ve all been there when Finance have asked for sickness to be lowered!), what difference does 10 seconds make on AHT (1 member calculate that 12 seconds increase would cost £ 1 million per year)
This is a good way of identifying any possible gaps, gaining buy in and generating the need to identify new ideas.
Negotiated Budget, is where top down and bottom up meet for healthy challenge and shared responsibility for the budget preparation.
Not surprisingly, we would recommend a negotiated budget approach where top down meets bottom up to drive healthy challenge, leading to shared responsibility and understanding.
Crucially, this should involve the whole business and not separate functions in siloes.
You might be thinking that “we don’t time to do the current method, so how could we do 4 budget types?”. The reality is, you are probably doing versions of these there may not joined up, or being done formally.
Starting with an incremental approach helps set a benchmark, the activity base then starts to add some high level detail, the zero based approach then meets this to identify any gaps, whilst the value proposition acts as the challenge to question how things are currently done, and what changes could be made.
At the highest level of our standards benchmarking we are looking for
Establishing interactive models which engage and influence. The key behaviours and understanding you need include:
- Business wide visibility and understanding on how the long-term forecasting models are developed and the assumptions within.
- Visibility of the impact of all significant factors on internal & external stakeholders.
- Business wide understanding of process for modelling change and factors which influence decisions.
Regular reviews and sign off sessions would involve:
- Use models interactively in meetings to achieve buy-in & accountability.
- Generate and evaluate opportunities for improving performance.
- Propose actions and priorities, offering supporting evidence.
- Put initiatives into place to make change happen.
3 examples, include recently accredited: Skipton Building Society
The routine practices embedded as part of the forecast process seem to make for a slick budget process. Having good stakeholder relationships in place has helped to establish forecast models which are trusted and understood. Quarterly reviews and short-term view support collaboration and shared understanding of the budget. Not surprisingly the new PowerBI tracker has received good feedback from stakeholders
British Gas, The budget process is robust with a focus on governance and accountability. The models follow a good methodology of using a baseline forecast them building different layers to reflect change initiatives and known activity which will impact supply and demand.
& at LV, What stood out about the longer term planning was how the model had been simplified. While still detailing key assumptions, it is easy to understand the impact of changes immediately and interactively with leaders.
It is no longer good enough to have:
- Prepare plans that bring together historical data and business judgement, Identifying issues, anomalies, errors and new trends – provide insight and influence decisions
- Track performance against parameters & assumptions in a regular cycle – support the education and accountability of key assumptions, adapting outputs to give appropriate information & level of detail.
Use the budget to set new “realistic” targets, for the customer, colleague and company.
Crucially, killing off old metrics, refresh and review all existing reports to reflect the new budget, targets and plan. Educate and talk about what’s happening, don’t assume everyone knows what you know.
Understand the gap between the different budget types to drive innovation and new ideas, new approaches to achieve these targets
Modelling the costs and performance, understanding the interdependencies. Setting the metrics, creating responsibilities and accountabilities.
Having a negotiated budget process brings together key stakeholders, so you can create a standard approach with understood variances where necessary. Crucially, this will develop understanding and support the creation of new targets, operational and performance indicators along with the Key Performance Indicators
Planning can be the Guardians of the Truth, bringing together the different functions.
Informing the business when targets won’t get met
Budget Planning: Bad Practice
What we have seen over the years, are a number of organisations who feel trapped by the budget They typically have:
A single top-down approach, a feeling of being done to and a feeling of that isn’t enough
This then drives a lack of understanding, which leads to no ownership or accountability
The habit is still to send out the same reports with the same targets on, and not refresh these for the new year. Also, to ignore the RAG status and alerts as there is a belief that targets can’t be achieved.
The budget doesn’t have a formal review, no quarterly refresh or half year appraisal, it is set for the year
And, even worse the new budget only starts as the current one ends. In the worse instance, I’ve seen it where a new financial year has started and there is no budget in place!
Budget Planning: Good Practice
In many respects the good to best practice is the opposite:
A negotiated budget with healthy challenge promotes belonging, collaboration up and down as well as across the business
The senior team will send out a statement to support the budget, with a single transparent message communicated to stakeholders and the whole business.
Reporting will be update to reflect the new targets, and everyone is helped to understand their role in achieving the objectives, along with business change programmes and new initiatives.
The budget provides a data checkpoint which is reviewed regularly, with operating reports acting as the dynamic report
The budget rolls into the future, with a minimum 4 quarters in advance, some having a 3-year horizon
As said at the beginning we have a mammoth task to forecast, plan and budget for the next 12-months, and there is a strong chance that the following year will be at best just as hard.
There will be the temptation to have a short-term, almost tactical view of the budget, as flexibility will be required to meet the uncertainty.
Likewise, there is a danger of looking too long-term, in the hope that everything will return to normal.
I don’t know the answer, and for each business, there will be a different solution, however I confident that following the best practice principles will support better decision making. I reference an article from Harvard Business School written in July 1984, I firmly believe that will still be relevant.
All we need to do is:
- Understand different top down and bottom up perspectives
- Set key assumptions, metrics and targets which drive the right behaviour, accountability and ownership.
- Develop a routine business practice, which promotes healthy challenge and above all else understanding.
Author: Phil Anderson