Rethink budgeting

In many companies the budgeting cycle is either ongoing or about to kick off, and depending on the organisation, the process is often either painful or very painful. Without going any deeper into the causes of the pain at this point, the other question to ask is whether the process serves the business in the best possible way. Is the company content in dusting off last year’s numbers and adjusting according to required cost savings and/or expected growth? Or is there a genuine consideration on how the resources should be used to advance the company’s strategy and profitability?

There are several different approaches to budgeting – the most sophisticated organisations use more than one approach in conjunction, in which case the difficulty of course is fitting the results together. One common budgeting method is to take the existing budget and the reported actuals as far as available, and tweak them according to cost indices, sales forecasts, cost cutting demands etc. This can produce good results, but the downside is an in-built assumption that the current resource allocation is already optimal, and that nothing in the dynamic has changed since the resource split originally was made or came into existence. That may be, but it is a big assumption to make [Insert here you favorite quote about the current pace of change].[Tähän kohtaan voit lisätä mieleisesi kliseen nykyisestä muutoksen tahdista]

Another way is to start with the aspiration: ”Sales must increase 10%”. Setting targets top-down via the planning process can also work very well, providing that there is a step at some point that determines which actions and resources are needed to reach those targets. Otherwise the amount of aspiration exceeds the amount of planning, and chances for hitting the target probably remain low.

Ideally the planning process should be driven by strategy. The starting point then is not maintaining the current resource allocation, but determining how best to use available resources to realise the company strategy. This could mean increasing the resources of one business considerably, and taking them away from another business or function. That of course can be politically very difficult, and cause quite a bit of unhappiness. However, the job of the management is to implement the company strategy, and resource allocation is one of the most concrete ways of doing that.

Using budgeting to further the strategy has been shown to be beneficial, both to the company and the CEO personally. According to a study by McKinsey, the third of companies having made most capital transfers between their business areas during the 15 year study period, were on average 30% more profitable to their shareholders than the third having made the least transfers. Correspondingly, the CEO’s who made less transfers than others were more likely to lose their positions.

This is obviously not to say that there should be a change of course every year. Indeed, if aligning resource allocation to strategy creates frequent swings, the company has more pressing problems than budgeting. However, if the general division of money, staffing levels and other inputs has remained static for a while, it may be time to take a good look at the justification for keeping it that way.