The Top 10 Traps of Budgeting - 10 главных ловушек бюджетирования

Tad Leahy

By Tad Leahy

Companies keep driving into the same traps in the budgeting process. The fallout can be serious in boom times; in the current economic climate, foibles can take an organization so far off course that it never gets back into the game. Here are the most common traps - from no-brainers to complex pitfalls - and tips for sidestepping them.

According to a business consultant, when one COO was asked how he plans to cope with his company's upcoming budgeting challenges, his reply was: "We just plan on making more money. Problem solved." That attitude didn't sound so crazy last year, but few companies can expect to increase revenue in a recession.

How are businesses dealing with the 2002 budget and the processes involved in creating it? Most are using basically the same methods they have always used. And they're running into the same obstacles they've hit year after year.

Here are the 10 most common traps that cause budgets to go awry in both the best of times and the worst of times - and suggestions on how to correct them.

1. Doing It Backwards

Perhaps the number one problem with budgeting is that companies dive into the process without first formulating their strategic plans. That approach is common but backwards, according to Omar Aguilar, executive director at Gunn Partners in Boston.

"The budget should reflect the resources needed to accomplish strategic and tactical plans, but companies do the budget without taking those considerations into account," Aguilar says. "Then they put too much detail into the budget to try to cover up this mistake. You need to define your strategies first, then lay out operational tactics for achieving those strategies, and only then should you begin to allocate the resources you need to support the directions you've chosen."

2. Costing in the Dark

Companies often lack solid costing information, so creating a meaningful budget is difficult. That was a problem Michael Odom faced as a new president of Phenix & Phenix Literary Publicists Inc. in Austin. "We didn't know what it was costing us to do business," says Odom, a former business consultant. "The company had been guessing what things cost, but there was no plan for out-of-the-norm contingencies and no accounting for the costs of tasks performed within the company."

William Levi, a CPA and budgeting consultant for the Lang Group in Bethesda, Md., believes most line managers don't understand their cost management responsibilities. "Managers need an education on how to develop a comprehensive model of what things cost," says Levi. "They need to look at the components required in making a determination of the cost, not just simply say, 'Well, we'll add 8 percent this year to this line item.' "

3. Taking It From the Top

Budgets dictated by senior executives who fail to gain adequate input from frontline managers usually result in disaster, says Paul A. Dunn, partner in the business consulting practice of Arthur Andersen LLP in Dallas. "The budget is developed by the CEO and senior managers based on strategies they formulate, but the business unit managers have no input," he says. "Consequently, they aren't aligned with those strategies. Then the business managers start complaining about unfair allocations, claiming senior management never had any real idea of their business needs," he explains.

When budgeting is a two-way exercise, managers feel ownership of the resulting targets, which motivates them to take responsibility for working within spending parameters. "It makes the budget more achievable because they're the ones who have the frontline view of the resources required to get the job done," says Kenneth A. Hiltz, principal of Jay Alix & Associates, a corporate turnaround and restructuring firm in Southfield, Mich.

4. Hitting Thresholds at Any Cost

Business managers' compensation frequently depends on their ability to hit budgeted thresholds. Rewards of this kind can lead to deception. "If the manager submits a number and it's approved, and then that manager goes over the number, they're tempted to hide the overage by deferring costs to a later period," says Levi.

A better policy is to base managers' compensation on hitting performance targets, such as an improvement in customer satisfaction or an increase in market share. Budgeting does help keep costs in check, but when enforcing cost controls could cause the company to miss a potentially lucrative investment opportunity, it is unwise to be inflexible.

5. Treating It as Written in Stone

The shortening time frames available for strategic planning have made sticking to one budget throughout the year an unrealistic goal. "Assumptions made six months ago are often so far off target that companies continually need to update where they allocate resources based on the information they have now, not on information they had six months ago," says Levi. "Artificial timelines like calendar-based budgets don't match up well with today's market dynamics."

Ideally, budgeting is an ongoing process in which those involved continuously use key performance information about the company to fine-tune allocations. That's not easy, though.

"If you try to transform it into a continuous process all at once, it can become overwhelming, so start with pieces of the budget," suggests Michael Pugliese, senior manager in financial services at KPMG Consulting in Chicago. "Prerequisites for doing so, however, include more advanced technological capabilities and standardization of data for quicker decision-making, and the implementation of a rolling forecast methodology."

6. Clinging To Spreadsheets

Spreadsheets were not designed for budgeting. Today's analytic applications open the door to a faster, more accurate process, as Erin Lavelle, vice president of planning and analysis at Mesirow Financial in Chicago, discovered when her company implemented more sophisticated analytic software in December 2000.

"We were trying to juggle a budget that had eight different methods for allocating resources, such as by time and by head count," Lavelle says. "With Excel spreadsheets, we couldn't standardize data without a lot of work, and errors were difficult to correct. It was so unwieldy." The solution was an analytic application that works faster and better "and took out the human element, which can transpose the numbers."

7. Putting a Round Peg in a Square Hole

Too many companies buy budgeting software that doesn't match their needs or processes. Then, rather than admitting the purchase was ill-advised, they compound the problem by attempting to shove a round peg into a square hole. "Companies try to make the technology fit into their existing processes, rather than determining what kinds of technology can best serve their existing processes, or reengineering those processes before buying the technology," says Aguilar. "Then when they don't get what they want, they blame the technology."

Levi agrees. "If you expect the mere purchase of technology to bail you out, you could end up just automating your mistakes," he says. "To maximize the potential benefits of the technology, you need a champion who knows how to use it. Otherwise you can end up just using 3 percent of its capabilities."

8. Using It as a Business Plan

The budget is often meant to be a motivator; thus, it's generally unrealistic, says Hiltz. When an overly optimistic budget goes on to become the basis for a business plan, additional problems can pop up - particularly if a bank is reviewing the plan.

"When a bank asks for a company's business plan, the typical response is to turn over the budget," says Hiltz. "A business plan is supposed to balance risks and opportunities. It's meant to be realistic. A budget is not. Yet many companies don't distinguish between the two. So they end up with overly optimistic business plans. Or they'll have a business plan that shows significant cost reductions, like cutting salaries by 20 percent, but no real plan for achieving that goal."

9. Downplaying Variances

Many companies report variances from budgeted allocations but fail to take the next important step: investigating why. "For example, why did it take six days longer to perform a task? Someone in the company should be in charge of the 'why,' " says Levi. The problem tracks back to a failure to establish in line managers a feeling of ownership of the process. If managers who were never consulted when budgeting plans and targets were created end up missing those numbers, they have little motivation to investigate the reasons for the overage "because they say, 'Well, those weren't my numbers anyway,' " according to Levi.

This lack of accountability stems from the finance manager's failure to sell the process to the people who will execute it. Employees don't understand the impact that missing budget targets can have on the organization. "They need to know how their input fits into the process, and then pride takes over to hit the numbers and find the source of the variance if need be," says Levi.

10. Automatically Going Into a Roll

There's been a lot of discussion about tossing out the traditional budgeting process in favor of a rolling forecast approach, which typically extends out six quarters and updates budgeting numbers each quarter based on the latest forecasts and strategy shifts. This approach is not for everyone, however.

"The rolling forecast works best when there's significant variability in the business," says Aguilar. "It requires using less detail in the budget than companies traditionally use and a level of sophistication in planning and forecasting that the company may not possess. Before going this route, take an inventory of your process quality, technological sophistication, forecasting acumen and willingness to work with fewer line items before making the plunge."

Established corporate cultures can be a major impediment to overcoming many of these budgeting traps. Companies that have used the same process for a long time have so much riding on it - in some cases even people's jobs - that it can be hard to imagine anyone other than the CEO stepping up and recommending change. A clear directive and sponsorship from top management are essential for a budget improvement initiative. And a change management plan is a good complement to any proposed alterations in the budgeting process. After all, those who want to revise this core corporate activity are treading on sensitive territory.

Forecast: Lack of Confidence

The following questions were asked in interviews this summer with 30 CFOs from companies of all sizes. The research, conducted by Redwood City, Calif.-based Closedloop Solutions Inc., revealed a general lack of forecasting confidence.

  • What is your level of confidence, on a scale of one to 10, that you will meet earnings expectations at the end of the quarter?Average confidence rating was 6.6.
  • As you head toward the end of the quarter, what do you feel most uncertain about?"Bookings forecasts" was chosen by 50 percent, "recognizable revenue" received 39 percent of the vote, and 11 percent of respondents selected "expense commitments." The CFOs surveyed also voiced uncertainty about product markets, customer preferences and profitability of strategies.
  • What is the biggest roadblock to gaining greater forward visibility and predictability of earnings?An overwhelming 71 percent said they don't see market changes from the front line, and 24 percent said they don't see expense commitments quickly enough.
  • Which part of your spending do you most often get surprised by?Forty-two percent said contractors and consultants, 16 percent said manufacturing costs, and 16 percent said variable compensation.

Among the study's recommendations was that companies need to find alternative approaches to forecasting, such as Web-based analytic applications, that give CFOs more frequently updated company information upon which to make their forecasts.

Budgeting Blues

Practitioners and experts alike are widely criticizing traditional approaches to planning and budgeting, according to research compiled during the first quarter of 2001 by the Centre for Business Performance at the Cranfield University School of Management and the performance service line of Accenture. The findings, listed below, are based on face-to-face interviews with executives from 15 global firms, including the likes of Shell, Ford, DHL, Volvo and Cisco, as well as discussions with over 30 senior analysts from Deutsche Bank, Morgan Stanley Dean Witter, Merrill Lynch, Prudential Securities, Standard & Poor's and William de Broe. The 12 most common complaints were that budgets:

  1. Are time-consuming and costly to create.

  2. Hinder responsiveness and are frequently an impediment to change.

  3. Almost never support a company's strategies and, in fact, often contradict those strategies.

  4. Require a process that is not value-added.

  5. Focus on reducing costs, not increasing value.

  6. Strengthen vertical command and control within an organization.

  7. Don't reflect the emerging initiatives, such as new network structures, that companies are adopting.

  8. Encourage gaming and "perverse behaviors."

  9. Are developed and updated too infrequently.

  10. Are based on unsupported assumptions and guesswork.

  11. Reinforce departmental barriers instead of knowledge sharing.

  12. Make people feel undervalued.

Among the study's conclusions: It's possible to improve shareholder value through planning and budgeting by focusing on better forecasting, better strategy formulation, more cost-efficient planning and budgeting, and - most of all - subordinating plans and budgets to strategies.

Originally printed in the November 2001 issue of Business Finance.