3 Reasons Your Budget Is Already Outdated
So it’s a new year and you have just started comparing actuals to your brand new budget. However already now you are finding that the world hasn’t developed exactly the way you predicted when you were compiling your budget "back in September". Perhaps you thought the oil price wouldn't go further down than 50$, that the USD/EUR wouldn’t go higher than 0.85 or that the Russian economy would bounce back in 2016. Obviously, none of this was true and while things might still turn the way you saw them chances are your budget assumptions will never be accurate and always be outdated once you begin the budget year. Here are 3 reasons why - your budget is a forecast, a target as well as a resource allocation.
- The forecast is supposed to be unbiased and your best guess for what will happen, but ends up being a compromise between what line managers are sure they can deliver and what top management feels the pressure to deliver
- A target is used for compensation purposes and will always be subject to some sort of negotiation which again distorts the forecast even further
- A resource allocation is supposed to happen continuously, but if you didn’t get your project in the budget then you are almost certain you won’t be able to do it next year
The solution is simple. Go Beyond Budgeting. Start by splitting up your budget into a rolling forecast, a target setting and a resource allocation. With this, you will achieve the following.
- Whether you do it monthly or quarterly you will continuously get a view into the future, supposedly unbiased as it’s not used for target setting or compensation. It’s important though that the organization trusts this link as otherwise they will start to get conservative with their forecast as they were with the budget
- A separate target setting process will enable you to link your strategic direction setting with your compensation. The targets whether they are annual like most companies or more long-term with strategy fulfilment in mind will now be based on where the company expects to be strategically at the end of the target period and also leave room for negotiation without distorting the companies view of the future
- The resource allocation will ensure that the "bank is open 24/7/365" and good projects always can get funds whereas bad projects don't necessarily get approved just because they were in the budget
This framework gives you a lot more flexibility to manage your company and make the right decisions. Have your company already gone Beyond Budgeting or are they still doing the good old budget?