The useful budget?

Fall of 2010. Many people across the world are engaged in a process that has polarized generations of business managers. Some love it. Most hate it. Yet, almost every company invests endless numbers of hours into the process. We are talking about the annual budget.

BEGINNINGS

The annual budget is a management tool that was invented to help managers guide their undereducated employees. It had its origin in the public sector. The annual budget provided workers with guidance and predefined resource allocation throughout a fiscal year. It helped managers control their employees. That was back in the 1920s and 1930s. A lot has changed since then. Volatility has increased, employees are highly educated and the speed of business has accelerated. But we are still using the same tool. Every year. Is that the right approach?

WASTED TIME?

Jack Welch famously called the budget a serious waste of time & resources. And indeed, I have worked with many companies over my career where the budget consumes an enormous amount of resources. One particular Fortune 100 company I met with, spends around 9 months per year working out their budget. 9 months! But the reality is that about 75% of all budgets loose their validity after only 2-3 months of a fiscal year. We spend so much time and get such little return?

DYSFUNCTIONAL BEHAVIOR

Many companies use the budget as the main pillar of their variable compensation scheme. As a cost center manager I get a bonus if I stay within my budget. As a sales manager, I get a bonus if I make my sales numbers. Unfortunately, experience has shown that this type of compensation leads to dysfunctional behavior. The cost center manager won’t invest in a useful activity only to stay within budget. The sales manager might cut some bad deals towards the end of year to make his number. And then there is sandbagging: people will do anything to protect their budgets. The cost center manager will try to spend his budget to avoid any potential cutbacks in the following year. And the story goes on and on.

A BETTER BUDGET?

We could spend all day arguing about the budget. But truth of the matter is that most companies are not ready to get ride of the process…yet. Clearly there must be some value given the enormous amount of time and resources? Personally, I do think that the budget can add value, but it has to be done in the right way.¬†Without going into any details, every company should consider a few things:

  • Less detail: Reduce the detail in the budgets. This speeds up the process tremendously.
  • Change compensation: Move away from the budget compensation to include more important metrics.
  • Update the budget more frequently: Once a year does not cut it, anymore.
  • Automate the process: Throw those spreadsheets away and speed up the process by using proper technology.

Over the next few weeks, I will drill down on some ideas. There are some great stories from my clients. Until then….Happy Budgeting!