Corporate Finance

Special Report: Building Better Budgets

Conventional budgeting struggles to keep pace with a volatile world.
David KatzOctober 28, 2015

Well entrenched though it is, traditional yearly corporate budgeting is coming in for more criticism today than it has at any time in recent memory. The dynamic nature of the digital economy is making it harder and harder for budgets hatched a year in advance — and based on a prior year’s experience — to keep up with current reality. In fact, “[t]he annual budget may be past its useful life,” write Gregory V. Milano and John R. Cryan in this CFO Special Report on Building Better Budgets.

2015_11_SR_Budgets_IntroGraphicIn fact, they recommend, senior managements need to “develop alternatives for planning and incentive compensation target-setting that decrease the dependency on the annual budget. Once that is achieved, the budgeting process can be significantly simplified, and once again become a cornerstone of prudent financial management.”

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The most visible proponents of the new wave of change are advocating zero-based budgeting. In contrast to conventional budgeting, which uses the previous year’s spending as a baseline and then just adds to or subtracts from it, zero-based budgeting forces managers to “start from scratch and justify practically every cost their units incur,” as we report in our lead article.

Leading the pack in the use of zero-based budgeting is 3G Capital Partners, a Brazilian private equity firm that has deployed it in its merged portfolio companies, notably at H.J. Heinz, which announced a merger with Kraft Foods in March, and at Burger King, which 3G melded with Canadian chain Tim Hortons in 2014. Beyond food and beverage companies, experts say that health care is also ripe for zero-based budgeting, while companies as different as Boston Scientific and the Tribune Co. are using the tool.

To be sure, the method isn’t for everyone. Focusing too much on near-term costs may hurt a company’s goals for long-term growth, opponents say. CEO Indra Nooyi, a former CFO of PepsiCo, threw cold water on the idea in a second-quarter earnings call. “[W]e are balancing top-line and bottom-line growth very, very judiciously,” she said. “When you embark on a zero-based budgeting program that [cuts] to the bone and jeopardizes your ability to grow the top line, I think that’s a formula for disaster.”

Indeed, at an overwhelming portion of companies, CFOs are still employing conventional annual budgeting to cope with a volatile world. In many cases, finance chiefs will have to find ways to make their traditional methods more flexible, according to David Axson. “In their hearts, CFOs have known for years that very detailed annual budgets predicated on a static set of assumptions are useless at predicting future business performance — never mind serving as a rational basis for allocating resources,” he writes in this special report.

“Now is the time to acknowledge this reality and move to implement a set of planning and budgeting processes that embraces, rather than ignores, uncertainty and volatility,” he adds.