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Improving the Agility of Budgeting

Written by Robin Dehondt

Since Covid-19, CFOs are waking up to new daily issues: raw material shortages, 10% indexations, increasing interest rates, etc. Each of these items endangers the profitability commitment towards the board during the famous budget cycle. As we reach new heights of volatility and uncertainty, more agile approaches to budgeting are gaining a lot of attention among finance leaders. One of those approaches is 'Beyond Budgeting'.

Conflicting objectives

The issue with traditional budgeting is that it tries to achieve three conflicting objectives (see exhibit 1).

  1. The budget is a realistic forecast of the future to control the company's financial health.

  2. But the budget also sets targets to motivate and promote performance.

  3. And the budget allocates resources by setting boundaries around future spending.

These conflicting objectives make the traditional budget process a heavy political game, requiring immense management time. Next, other issues arise, such as year-end spending fever, lowballing to maximize incentives and non-responsiveness to unforeseen events.

The answer to the beyond budgeting movement is to separate the three objectives and establish distinct processes and practices for each (see exhibit 2).

Unbiased, accurate forecasts

Ask a unit manager for a forecast, knowing that the submitted number will serve as a basis for a target or available budget. You could have reasonable doubt that the forecast will be nowhere near his "best guess of reality". That is why a prediction should be neither the first bid in a target negotiation nor a request for resources. Forecasting should be its own separate process, dedicated to producing the most realistic prediction of future performance.

Forecasts should also be updated as often as needed. Since the outside world moves so quickly, it is advisable to proceed to rolling forecasts, updated at least quarterly and monthly. Usually, forecasts are less granular than previous budgets because they are not conducted as a detailed, bottom-up exercise. Best-in-class forecasting leverages AI to create unbiased predictions of the future.

Stretched, strategic targets

Now that we've separated the forecast from the target. Top management can set more stretched targets to motivate employees and ensure strategic execution. The targets are often derived from a longer-term strategic plan. Best-in-class target setting leverages external benchmarks that compare performance versus competitors and goes beyond purely financial metrics.

The usefulness of separating targets and forecasts becomes clear when we compare them. If the forecast is below the target, more actions are required to achieve the target. They foster discussions focusing on needed forward-looking action rather than explanations or excuses for past results. Finance has an essential role in framing and preparing those management discussions accordingly.

Transparent, dynamic resource allocation

In a Beyond Budgeting context, resource allocation is no longer rigidly fixed by a given budget figure for a year. Instead, according to continually updated and unbiased forecasting information, resources are dynamically allocated to business needs. A company will instil a continuous decision process, allowing decisions to be made about resources with full transparency throughout the year. This way, funding is always available for promising ideas or ventures while avoiding silo thinking and suboptimization. Transparency on spending becomes a "social" control mechanism that is highly effective at removing unfair, non-value-adding spending.

In the following article of this finance series, we will focus on the first objective and discuss the concept of rolling forecasts in greater detail.

Need help in implementing the beyond-budgeting approach? Do not hesitate to reach out to our finance expert, Robin Dehondt.


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