XLerant

It Takes A Village To Build A Budget

Village - XLerant
There’s no doubt that Finance runs the budget process, and probably should. But we can get so focused on the mechanics of getting the budget done, that we can almost forget that it takes a village to build it.

Let’s keep in mind that the purpose of budget process is to allocate resources, and a successful budget process is one that optimizes the allocation of those resources. That might sound a little academic, but it’s just a way of capturing what happens in reality. The budget process results in funding for this program and not that program. Approval to staff up in this area, not that area. Agreement to invest in these operations, not those. Direction to increase marketing spend in these segments, not those segments. These are all business decisions about the allocation of resources, and if those decisions are made well, the organization will be successful.

Making those decisions – effectively – takes a village. Why? Because no one person, no single functional area, no level of management has all the information (much less all the answers).

Everyone has to execute their part of the budget process effectively if the end result is the optimization of (scarce) resources.

So who are these villagers and what role do they play?

SENIOR EXECUTIVES

These are the decision makers. They decide who gets what. Which programs get funded and which ones get cut. What spending increases are reasonable and desirable and which are not. What strategies will be invested in and which ones won’t. Ultimately, their business decisions about how the organization’s resources are allocated will drive success or failure. So let’s make sure we give them what they need.

What They Need to be Effective

They need information. But not just pie charts, gauges, and numerical data Finance tends to stuff into dashboards.

They need to understand the proposals coming up from the organization. They need to understand the spending requests and the rationale behind them. They need to understand what the assumptions are behind revenue growth or decline; and how they are tied to spending requests (if at all). They need to know what the funding requests are and what they mean for the organization. In short, they need to know the story behind the numbers.

What Does Finance Give them Today?

The primary vehicle used today to review budgets is a comparison P&L. More specifically, a list of General Ledger accounts and the amount projected in the Budget compared to another time period (e.g., prior year). Variances are expressed in dollars and percent.

Now, are their other statistical reports used in budget review sessions with Senior Executives? Yes. But if you videotaped the typical budget review session, the majority of the time is spent on P&L comparison charts.

Current Shortcomings

Comparison P&Ls are helpful and necessary. But they are painfully inadequate. They generate 5 questions to every 1 they answer.

Let’s look at an illustration. Say we’re looking at a comparison P&L and notice that Travel related expenditures are projected to increase 20% in the budget. What’s the typical next step? To find out which departments are areas are responsible for the increase. So we “drill down” and find out that the Marketing department is responsible for a good portion of that increase, no surprise there, but the Legal department is responsible for the rest. Okay, now what?

Well that’s about as far as our analysis can take us. Sure, we can look at 5 year trends, or compare these “outlier departments” to the norm, or do other types of statistical analysis. But none of that will help the senior executives answer the question “Should we approve the spending, is it in the best interest of the organization or not?”

Let’s take another example, involving Revenue. The P&L comparison tells us Revenue is projected to rise 10% in the budget. So what? Unless “the story” is embedded in the budget, Senior Management can’t evaluate a 10% increase.

Maybe the story is this. Half of the budgeted revenue growth is tied to a projected increase in the overall market. The other half hinges on a successful new product launch.

With that in mind, Senior Management spend more of their time discussing the new product launch and ensuring the proper resources have been allocated to it. Knowing the story behind the numbers completely changes how Senior Management reviews budgets.

We could give other illustrations, but the message is the same. Comparing General Ledger accounts and amounts isn’t enough. It won’t get us the answers Senior Executives need to make informed, intelligent decisions regarding the allocation of resources.

Suggested Improvements
Enable a Drill-Down to “Why”

Today, the budget process is wired to answer the “how much” question. Not the “why” question. But we need to be able to drill down to “why” if we’re to empower Senior Executives to make smart budget decisions.

You can’t “drill down to why” if there is there is no “why” there to begin with.

So the first step has to be to develop, capture, and document “the why”. In other words, as the budget is being developed, the rationale is being embedded. We’ll explain this in more detail when we look at the role of the Budget Holders; but it’s simply not sufficient to budget a number. The thought process that produced that number must be documented, otherwise there is no “why” to drill down to.

In some cases the rationale is quite rich and complex. Such as all the rational and assumptions behind budgeting for a new product launch. At other times it is simple, such as budgeting for office supplies in the Legal department (e.g., the rationale is simply we want to keep spending flat to last year).

Be it simple or complex, the rationale needs to be embedded in the budget if we’re going to enable a drill-down to the why.

Focus Budget Reviews on Business Decisions

Do we really need to bother Senior Management with approving an office supply budget in the Legal department for $200? Probably not. Especially if the guideline was to keep costs flat to last year and the legal department is accommodating that requirement.

Where Senior Management really needs to focus their attention is on the investments we’re making in the business, and how they support the overall strategy. It’s the job of the Finance department to facilitate a budget process to make that happen. That means preparing reports and presentations that focus attention and decision making where it’s really needed.

Eliminate Ambiguity

There are certain questions that drive Senior Management crazy if they can’t get a straight answer. Like “did we budget for that?” or “who budgeted for that?” or “are we sure we didn’t count it twice?”

It drives them crazy because ambiguity retards decision making. It’s a waste of Senior Management time to sit in a meeting where who budgeted for what is being debated in real time. So design your budget systems and processes to mitigate ambiguity. Make assumptions and rationale clear and explicit, and ensure they’re well documented and communicated.

Baseline Your Budget

This is probably the most technical recommendation we have, and perhaps among the easiest to implement because it is technical. To help focus Senior Management on what’s important, and save them from distraction, create a baseline version of your budget with basic assumptions.

The idea is to keep that baseline simple and easy to understand. The guideline for salary increases is 3%. All non compensation related spending will be kept flat to prior year. Revenue is expected to rise at the industry rate of 4%. You get the idea.

Now the reaction among your Budget Holders is likely to be “But it’s not that simple, I can’t possibly keep my costs flat versus last year because of XYZ.”

That’s exactly the reaction that you want. It’s precisely the “XYZ” that Senior Management should be focusing on. That’s where the meat of the business conversation is. That’s where the decisions need to be made.

So create the baseline budget, and have the Budget Holders provide the business rationale for needing more spending, or for not keeping up with market growth in revenue.

BUDGET HOLDERS

The role of the Budget Holders, first and foremost, is to run the business. We’re going to be talking about budgeting in a moment, but we need to acknowledge that these are the people running the day to day operations of your organization. They make decisions on the front lines every day that create or destroy value.

The problem is they often don’t see how budgeting fits in. Budgeting is seen as a distraction, or worse yet, a waste of time. So they tend to push budgeting off to the Finance department, or do it begrudgingly with the back of their left hand. The result is often a poorly documented budget, one that’s lacking in detail and buy-in.

That’s not at all how it should be.

The role of the Budget Holder in the budget process is to make her case. She knows her business. She knows what should be done and why. She’s got great ideas about how her side of the business can be improved and what it’s going to take.

Trouble spots? Weak Spots? Threats she see looming from her competition? She knows them all, and how to respond. Just ask her.

That’s the funny thing. If you talk with Budget Holders they can tell you a lot. They have an amazing amount of insight. They have powerful suggestions. They can tell you pretty clearly why they need a particular budget request and what it’s going to do for the company. Yet somehow the “story behind the numbers” stays stuck in her head and isn’t embedded in the budget.

That’s what we want to change. And that’s what we need to change if at the end of this process, Senior Management is going to make informed, intelligent decisions regarding the allocation of resources.

Suggested Improvements
Leverage the Baseline Budget

We talked earlier about the concept of a baseline budget — applying baseline assumptions to a budget, and enabling senior executives to focus the bulk of their attention on what’s beyond the baseline.

The same baseline budget can be used to free up Budget Holders to make their case for going beyond baseline spending (or to explain coming up short of baseline revenue growth). But to make their case, they need to embed their business rationale in the budget. And that leads to the next recommendation.

Budget in Discrete Spending Packages

Marketing managers tend to think in terms of marketing campaigns. IT managers tend to think in terms of IT projects. Human Resource professionals tend to think in terms of training programs. More senior level executives tend to think in terms of strategic initiatives. You get the idea.

What do they all have in common? They all impact multiple general ledger accounts, and are best understood by “bundling” the related spending into a discrete spending package.

To optimize the allocation of resources, budgeted spending beyond the baseline should be identified in discrete Budget Packages. That’s the general term, but it means identifying spending, discretely, in a way that makes business sense to the Budget Holder (e.g., by marketing campaign if you are a Marketing manager). It’s a win/win because Budget Holders can budget the way that they naturally think about the business, and people reviewing those budgets have greater clarity on what they are approving.

Embed the Rationale in the Budget

Budgeting in discrete spending packages is probably the very best way to communicate budget requests, but it’s not always the most practical. Sometimes the best way to communicate the rationale for, say budgeting a department’s Seminar Expense, is to list the planned seminars and their expenses.

Or, if you are a college administrator budgeting for something related to student headcount (say, Tuition?) then embedding the assumption used for that budget driver would add a lot a lot of clarity when reviewing the budget.

To provide (yet another) example, it might make sense for me to budget Travel expense on my department’s headcount. Or it might make sense to budget Professional Fees on a Unit X Rate basis (e.g., 500 consulting hours at $250/Hour).

And, of course, a brief written explanation always goes a long way.

The problem today is assumptions are not embedded in the budget, so the rationale behind the budget is missing or obscured. That really gums up the budget review process, and frustrates Senior Executives who want to make informed decisions.

So embedding the rationale/assumptions directly in the budget should be a primary goal of anyone looking to improve the process.

THE FINANCE TEAM

The role of the Finance organization is to facilitate a budget process that produces the optimal allocation of resources. That’s easy to say, hard to do. All of the recommendations we’ve made so far represent what we suggest the Finance team execute (directly or through others) to achieve that outcome. But we do have a few other specific recommendations for the Finance team.

Suggested Improvements
Don’t Focus on Financial Models.

As Finance professionals we gravitate to building financial models for everything. It’s like that expression “We’ve got an App for that” only it’s “We’ve got a model for that.” Want to budget for plastic forks in a fast food chain? We’ve got a model for that. Want to budget the amount of revenue a retailer can make from SKU 235555-60-200? We’ve got a model for that.

Look, it’s not that these models aren’t valid or helpful. It’s just that we wind up owning them. And as long as we own them, we own the results they produce. Let the Budget Holder develop the budget the way they think. It may or may not wind up getting approved as submitted, but they’ll own the results.

Don’t Lock Down Spreadsheets – Find a Better Way

If there’s one thing we know in Finance how to do is lock down a spreadsheet. It’s the only way we know how to keep control. But that control comes at a high cost – frustrated Budget Holders and a lack of buy in to the numbers the locked down spreadsheet produces.

You need to provide your Budget Holders with flexibility, but in a controlled environment. Ideally, you’d want to permit your Budget Holders different options for creating their budgets, but without necessarily having to write formulas (which, let’s face it, they might mess up). If those formula-free options cover 90% of your common Budget Holders, then you could focus your personal attention on the 10% with advanced needs.

Start by Asking the Right Questions.

This is the last piece of advice, at least in this blog anyway. I’ve been told that Einstein once said, “If I had 60 minutes to solve a problem and my life depended on it, I’d spend 55 minutes determining the right question to ask.”

So much of what we can do to improve a process depends upon the question we’re asking. If we ask the question, “Which new variables should I add to my model?” you’ll invest your time and energy in getting that answer. And at the end of the day you’ll have a model with more variables, but probably no more buy-in to the results.

A different line of questioning is this: How can we can more engagement from line managers? How can we get more willing participants in the process? How can I increase accountability and ownership of the numbers? How can I make the budget process less of a mechanical exercise and more business oriented?

We’re only human, and we tend to gravitate to what we’re good at. And for Finance people that means when we see a problem we convert it into a spreadsheet. But if we want to reach the goals we set out in the beginning of this blog – to design and facilitate a budget process that optimizes the allocation of resources, we need to move out of our comfort zone.

Because the answer doesn’t lie in a spreadsheet, but in people.

Wrapping Up

I realize this blog post is longer than most, but there is a lot to be said. And re-orienting the thinking around budgeting isn’t easy and it doesn’t happen overnight.

If you’ve taken nothing else away from this blog it should be this. Budgeting should be a process that helps organizations make decisions – smart, well informed decisions. And that, my friend, takes a village.

 

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