What about the budget?

In the last blog post I defined a rolling forecast and demonstrated how it could be used to improve an organization’s decision making process to allow it to become more nimble and agile. I also rose the question of what should be done with the annual budget. I’d like to take a moment now to provide my thoughts on why the annual budget remains a valuable management tool and why organizations should not be too quick to abandon it.

Much has been written and said on what is wrong with the budget in its current form at most organizations. In summary, the budget:

• Takes too long
• Is too detailed
• Is out of date before it is completed
• Is too rigid
• Promotes poor spending habits
• Is disconnected from strategy
• Is focused on the wrong time horizon
• Is tied to compensation promoting poor behavior
  
  

With such a long list of issues, it is no surprise that many recommend abandoning the budget altogether. However, I caution against this approach, since the budget still has value for an organization if it is done correctly and is supplemented with tools that address its short comings, such as a rolling forecast.

The bible on budgeting was written almost 90 years ago by the founder of the consulting firm McKinsey & Co, James O. McKinsey. He articulated very clearly how a budget should be created and the value that the budget offers an organization. Though much has changed, many of these values are still applicable today including:

• Organization wide buy-in and commitment – A budget is an excellent tool to ensure that every level of the organization has a voice in how its plans are created and conducted.
• Scalability – By providing a guide on how resources should be deployed, a budget allows an organization to scale by not requiring executive level input of many small but critical decisions.
• Training and managerial development – The ability to develop and execute effective plans is a skill that is learned over time. It is not realistic to think that mangers who have never been tasked to develop plans will magically become planning experts when they are promoted and tasked with developing a plan or forecast.
  
  

In addition, the budget is a process that has developed over time and as such it is also not realistic to think that it can be suddenly switched off. To retire a process that is often ingrained in an organization’s DNA takes time and careful planning, not to mention that a new process must be developed and accepted by the organization to take its place.
​
Instead of taking this approach, I recommend that a rolling forecast be used to supplement the annual budgeting process. A rolling forecast, by its very design, is much more nimble and allows for an organization to make decisions and create plans very rapidly. It addresses the core issues and criticisms of the annual budget by being created and managed at a higher level, allows for underlying assumptions to be updated, focuses on the core business drivers and forces an organization to continually plan forward and not to the end of the fiscal or calendar year. In short, the rolling forecast and annual budget when used together effectively, can allow an organization to create accurate long term plans as well as focus on short term execution simultaneously. In today’s rapidly changing world, both skills are critical to ensure success.