The ROI of the Budgets

Planning, done well, always has benefit. There's a reason why the saying "measure twice, cut once" has such a long life span.

Budgeting SHOULD be analogous to planning; indeed, budgeting SHOULD be the financial "fleshing" of any planning model. From that perspective, I believe that budgeting has immense value, primarily in three areas:
1) Better understanding of the business - it's funny, but when you plan, and put prices on your plans, it has a way of bringing all kinds of assumptions to the surface. The simple discipline of budgeting can be used to help a company keep focused on what's important, and therefore to identify (and shed) those things that aren't
2) Ability to make decisions - when you quantify the plans of the business, you can then "more" objectively make decisions about what to do, what to postpone, and what to not do (or stop doing).
3) Understand linkages - It's amazing how many times senior executives, trying to build out their budgets, will realize that they need information from someone else's plans to finalize their own. This can lead to very constructive improvements in the cohesiveness of operations, as decision makers get a more-visceral understanding of each other's needs.

OK, that's the perfect world. In reality, budgeting is too often unrelated to planning. Whether for political or other parochially-driven reasons, the operations of the company become siloed so that intracompany planning becomes either impossible or too difficult to pursue. Real planning often takes place as a tactical exercise, and is more a matter of managing the resources provided, rather than considering how to obtain the resources needed to hit strategic goals.

As such, the annual budget is often an accounting-led exercise, which has little chance of impacting the way the business is done, except as a constraint. In such a world, the best that the budget can be is a way to more-objectively manage scarce resources.

So, in answer to your question, could many companies do without their current budgeting effort? Probably, because their current process is likely not delivering the value it should. Would they be better off changing their approach & culture (where necessary) to embrace a true planning process with financial inputs? Yup, but I wouldn't hold my breath...

Budgeting per se is a waste of time, money and is usually DOA. Just ask Jack Welch retired CEO of GE. For a full discussion of this go to Beyond Budgeting Round Table at www.bbrt.org/bb-briefing. What is necessary is an eighteen month operational rolling forecast updated quarterly and an annual forecast updated yearly.

Compensation based on plus/minus performance to budget should be trashed and a better compensation system developed.

An organization has to have a planning porcess, just not a budget process.

The planning process should also be tied into your BI/BA systems for drivers as well as your Balanced Scorecards.

Drop me a line of you want more detail.

Good answers, so far. But no one has touched on whether the typical budgeting process brings "measurable benefit" to the companies thus engaged in the process.

Any takers?

Mr. Curtis:

Thanks for the encouragement. Your experience is similar to that which I've heard repeated time and time again: Budgets and even the word itself: "budget," tend to have the effect of focusing everyone's attention on costs and expenses to the detriment of growth.

Unless an executive management team is proactive in the extreme (or an industry just happens to be booming), I seldom here about "budgets" focused on "increasing throughput by 160% over the next 18 months," or anything similar.

I'd be interested in hearing what the CFO community has to say about this matter.

Crunching numbers just to generate budgets doesn't add any value. What is worth it is to develope a truly planning process to explain how every area will achieve its objectives. During that process resources are allocated to most profitable activities. Other big benefit of budgets is to ser commitment to achieve objectives.

Great discussion! The key is "Investment-based Budgeting."
http://www.focus.com/questions/finance/roi-budgets

A traditional budget for what managers want to spend (compensation, travel, training, etc.) is of little value.

A budget for what a business-within-a-business plans to "sell" the enterprise (the full cost of its products and services) has many benefits.

* Budgets are based on the investment opportunities at hand.
* Strategic alignment is virtually automatic when the best investments are funded.
* Expectations match resources, so staff can run sustainable businesses.
* The dialog shifts from micro-managing staff to a businesslike discussion of how the various functions within the enterprise serve one another.

If anyone is interested in case studies and white papers, see:
http://www.ndma.com/resources/fc-325.htm

--Dean

Gabriel:

You are correct with regard to "crunching numbers" versus actually "planning." However, (be honest with me readers) how many times have you seen numbers produced for a "budget" because management (or circumstances) dictated that's what the numbers "had to be," but no one in the organization had a real PLAN for achieving those numbers.

This is the kind of self-deceit that is most damaging to organizations. Everyone in the organization (frequently), from top executives (who "accept" the budget and institutionalize it) to middle management (who produced the budget) to the working stiff (who just hear about the budget) know that there's nothing but HOT AIR behind the numbers -- no REAL PLAN on how to achieve them.

Preparing such a budget is a WASTE of time, energy and money and is damaging to the morale in the organization itself. It demonstrates a wholesale lack of integrity in every respect.

Don't you agree?

Dean:

Yes! Every budget that is worth developing is a "investment" budget. If you are going to spend the time, energy and money to create a budget you're already INVESTING regardless of whether there is an accounting entry to that effect.

However, I believe there is real danger, numbers can be misleading, and organizational strength undermined in calculating intra-company "sales." The formula that eliminates all of these risks is

ROI = (delta-R - delta-TVC - delta-OE) / delta-I

ROI equals the change in Revenue minus the change in Truly Variable Costs minus the change in Operating Expenses divided by the change in Investment. (Carefully limit TVC to TRULY VARIABLE COSTS, not partially variable or allocated costs, however.)

I think much of this discussion misses the point. What if there was no budgeting and forecasting and management was making its decisions without the benefit of seeing the potential impact on future accounting periods and future cash balances. Even bad forecasting and budgeting will surface allocation of resource issues that if not investigated and compared to business objectives will lead to overspending and bad allocation of resources.

Sure in most organizations, the first pass of many budgets is more of a wish list than a true business needs assessment. But in the refinement and discussions that are needed to establish a plan and yardstick for spending and investment, the fluff is eliminated and management has a plan against which proposals for spending, hiring and the like can be compared. In the case of a venture backed company, which is common in Silicon Valley where I work as a management consultant, the remaining months cash is critical to manage. Good budgeting and forecasting and spending dicipline resulting from this process is critical to having the cash on hand that is needed until more can be raised. For larger companies, making sure that bank covenants can be met may be another reason to make sure plans and spending are under control through thoughtful budgets.

The specific question here is focused on measurement; can the process be justified by objective measure. I think this is hard to do. For example an poor decision avoided through analysis of the consequences in the budget model is an example of money saved that may not be written down. Higher prices through better analysis of margins also factors in.

I am and remain a strong proponent of effective budgets and forecasts and see the results daily in my work.

Rick:

I am and remain a strong proponent of EFFECTIVE BUDGETS and FORECASTING, also. Provided the GOAL is ROI for the time, energy and money expended in the process and the results are truly EFFECTIVE BUDGETS, not just more paper.