Management Accounting

Metric of the Month: Budget Iterations

The number of budget iterations affects budgeting, planning, and forecasting.
Mary C. DriscollSeptember 2, 2015

That cool breeze you feel isn’t the first sign of fall – it’s a collective sigh of resignation from controllers across America. Budgeting and planning season has begun again.

METRICOFTHEMONTHIn an ideal world, the budgeting process would be fast and painless. But for many division heads, finance teams, and CFOs who see the same spreadsheets crossing their desks over and over, it is an exercise in frustration.

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Curious how many budget iterations companies generate before approving a final, enterprise-wide budget? So were we at APQC, the nonprofit business benchmarking and research firm I work for. So we dug into our Open Standards Research database and pulled out metrics from companies (of all sizes).

The top performers in this exercise represent the best 25% of the data set (in all, 485 companies based in the Western Hemisphere). These winners get the job done in three iterations or less. Meanwhile, the bottom 25% goes through nine or more different iterations before finally settling on a budget. In other words, the bottom performers are doing three times as much work as those setting the curve. (See graph.)


Mary Budget Iterations


What practices help to streamline the budgeting process? Forecasting guru Steve Player of The Player Group told me that “companies [should] eliminate the budget process entirely.” To be sure, he recognizes that some finance staff may not yet be able to do that. “But for whatever political reason you cannot get rid of it, then you should minimize the damage by shrinking the process down to one or two budget iterations. And that starts with senior management telling the business units what is expected and why. The unit heads are better off focusing plans on the big rocks — the key drivers — instead of the minute details at the chart-of-accounts level. The key drivers tell you what you’re capable of.” Player also suggests compressing the budget process from multiple months in duration down to one month or less.

It’s also important that the senior executive team establishes stretch goals for revenue and earnings that are within reason. Selecting a “finger in the wind” multiplier for year-over-year growth can backfire. Say, for example, that the gum division of a large food and snacks company achieved $50 million in revenue and generated 5% profit (before interest and tax) in 2014 and is on track for $70 million in revenue and a 6% profit in 2015.  In that case, it may be tempting for leadership to throw down a 2016 revenue target of $100 million with a lock-step bump in expected profit. But, really, how doable is that?

To achieve this tough, new goal, the leaders of the gum division may be forced to venture ill-equipped into new terrain. They know that they can’t just sell more gum without doing something differently. So perhaps they might start eyeing overseas expansion and/or new marketing or packaging campaigns. At the height of budget season, with the pressure on, it may be tempting for unit managers to skip the steps necessary to assess in a systematic way potential strategic risks that, if they materialized, would send the gum business way off track. Any target selected should be explicit about what is expected in the overall operating environment.

Another factor is the budgeting process itself. The most efficient companies ensure that every division, everywhere in the world, uses the same definitions and budget categories as the parent company. Many use pre-populated spreadsheets or cloud-based budgeting tools. Such standardization allows the controller to easily and accurately roll up multiple budgets into projected financial statements that align with financial reporting requirements for investors and auditors.

In sum, the top performers work hard to implement sound practices. When senior management sets the right tone and approach, and when financial planning and analysis staff can provide the budget owners with access to useful insights on key business drivers, organizations can take time, money, and frustration out of the budgeting process, and, as Player says, “be more real and much more effective.”

Mary Driscoll is a senior research fellow for financial management at APQC, a nonprofit business benchmarking and research firm based in Houston.