Few activities in an enterprise are more ubiquitous – or reviled by users- than budgeting. What should be a reasonably straightforward exercise of forecasting capital, personnel and operating needs and the assumptions that drive those needs often turns into a highly complex, multidimensional exercise in iterative futility. “Tell us how much you need. Nope too much. Cut it by 10% and tell us again. Still too much (the other guy went up by 3%). Cut it again.” And so on. On top of it all, there’s the data. And the reports. And the supporting schedules.
While there are numerous perspectives on Planning and Forecasting (Rolling Budgets & Plans, Continuous Planning, Top Down-, Bottom Up- and more), the purpose of this article is to show how taking a rigorous approach to information management can streamline the Budgeting and Planning process and help to add information value to budgeting and planning data.
Planning vs Budgeting vs Forecasting
These are terms that are sometimes used interchangeably, but that each serve a distinctly different role in a complete Budgeting solution.
This refers to a very high level set of targets and hurdles, articulated in order to set a strategic direction. The Plan is typically prepared by a strategic group of the firm’s leadership using summary account (often reporting line item) level of detail, and reflects more of an external focus. That is, the “plan” shows how the organization’s financial and operating plans roll up so that investors and owners can plan and plot the general progress of the firm. Plans are typically on a multi-year cycle and updated annually.
Budgeting refers to a detailed program of how the firm is going to execute against the plan. Budgets are prepared at a level of detail that corresponds to how actual results are to be recorded. “Budget vs Actual” is simply a yardstick for measuring how we performed against what we told our leadership we would do when we submitted our budgets. Budgets typically are not updated and do not change over the budgeting horizon (typically a year). At the same time, when a dramatic (and usually unforeseen) business event occurs within a budget cycle, basic budgeting assumptions may change and the relevance of the original budget can decrease dramatically. This can have dramatic consequences, when individual employees’ compensation is based on performance against a budget.
Forecasting or Projections
Like a used car, the value of the budget usually diminishes the moment it “goes out the door”. Assumptions change, business rules change and things happen that are outside of the control of the budgeting manager. For this reason, most firm’s have projections or forecasts. The forecast is simply a reflection of our new best estimate of how the remainder of the budget cycle is going to finish. The forecast or projection typically includes out year-to-date actual results along with our best estimate of the remainder of the budgeting cycle.
Variance and Exception Analysis
Most managers like to track actual results against track all three numbers (Plan, Budget, Forecast) – although, since Plan numbers are typically focused on higher (more summary) levels of detail, actual vs plan analysis is most valuable only at a roll-up of cost centers (profit centers, departments, business units, etc.). The most important of the analyses, however, compare actual results against budgets (how well did we forecast our sources and uses of company funds at the beginning of the year), or those that compare actuals versus projections. Both of these analyses take a forward looking approach as well as a retrospective viewpoint in that the focus should be Budgeting as a Component of Your Performance Management Framework
Typically, budgeting actually begins with planning. Planning is a related discipline in which targets are defined for certain revenue and expense (and maybe capital and headcount) targets, so that a higher level goal can be set. The goal generally serves a dual role. First, the goal acts as guidance (either a target or a hurdle) for the line and staff managers as well as the enterprise, it also provides firmwide management with a high level benchmark for strategy. The targets are designed to demonstrate how certain strategic moves should impact the P&L, Balance Sheet and Cashflow over a defined planning horizon. Maybe we’re introducing a new product, entering a new market or adopting a new pricing strategy. Maybe our strategy is to “stay the course” and let last year’s strategy play out. Whatever course the firm is taking, targets communicate the demands on a firms financial and human resources and can usually be expressed at a somewhat summary level. As targets become more detailed, their value relative to budgets diminishes. In essence, they become the budget and the role of the line or staff manager becomes more executional and less directional. Fundamentally, the target should be the “what”.
On the other hand, budgets represent the “how”. Budgeting, at its simplest, represents predictive analytics. By this, I mean that you seek to have operating line and staff managers estimate how much money they will need over a given time period to produce a target revenue and profit. (Some firms may take this yet one step further to predict cashflow – but that will have to be another topic for another day – er – posting). Budgets take the input of the managers actually responsible for expending resources that will ultimately drive the profitability of the enterprise. How many accounts payable clerks will it take this year to produce 1 widget that the marketing guys tell me I can sell for $x and that the accounting guys tell me I can sell for $y for a profit of $z? How many trips to Cleveland? How many pencils? From a predictive perspective – how confident am I that I am right (budgets vs actuals)? Am I willing to bet my bonus on it?
From a systems perspective, budgets represent a poster child for large, federated data architectures. Most conscientious managers want to be able to present their budgets along with the drivers behind their predictions. Maybe a specific cost driver is a number out of the Financial Ledger (# of BU’s, # of Accounts). Maybe it is out of the Supply Chain system (Orders, Units on Hand) or maybe the Personnel system (Headcount, Hours Worked). Often the driver of a budget amount is not stored in an ERP system at all but in some structured or unstructured data store either from elsewhere in the enterprise or perhaps from the web. It is at this point, that budgeting becomes a data problem – and not just a process problem. No longer is the budgeting manager or director responsible just for budget data, but for budget driver data as well.
From the executive viewpoint, it is the management of the drivers that will result in real bottom line improvement. By managing the the details that really drive budgets (headcount, units sold, assets under management, square footage, etc.), management can actually lead the organization into a more proactive form of management. Budgets become not only a tool for communicating direction to investors and other stakeholders (often including employees), budgets become a tool for actively managing for results. That is, budgets become a tool for measuring and managing performance.
Components of a Financial Budgeting Solution
You can think of your budgeting solution as a the management of a collection of performance measurements. These measurements must collectively encompass:
* Fixed Assets and Capital Requirements
* Revenues, Direct Expenses and Gross Margin
* Positions and Human Capital Costs (salary, benefits, etc.)
* General and Indirect Expenses
These “sub-budgets” collectively form the true performance management framework for the firm over the budgeting horizon. Typically, many firms address each of the component pieces discretely, but it is the package – taken in its entirety – that really creates a proper reference architecture for a performance budgeting and planning solution.