Well, maybe that’s going a little too far because the budget does serve one purpose: to enforce strict fiscal adherence across the entire organization to predetermined annual targets set forth by the executive team in advance of the fiscal year in question. These targets are commitments transposed in the budget into initiatives and action plans while being reinforced through individual performance contracts. Because of this commitment to a target defined by other parties budgets tend to have an overwhelming power over the workforce to meet these commitments at any expense. As a result, budgets can drive the wrong behavior where managers do things like hoarding their budgeted dollars as entitlements and not scarce resources that should be allocated across the business based on need and potential ROI. Budgets have been derided by most management experts as worthless and weak. Indicative of the potential problems that can arise in budgeting, Bernie Ebbers, former WorldCom CEO, famously used to tell his department heads that no matter what they had to finish the year 2% below their budgeted expense numbers.
Still, not all companies budget processes are wasted efforts. For some companies, the budget has its place in the executive suite but, as a tool to manage the business more efficiently and effectively, it fails to deliver. Why is that, you ask? I’ll answer with another military related maxim:
“All plans are great until the first shot’s fired”
The problem is that business conditions which guided the budget’s target setting process are no longer the same. Things have changed. The budget’s assumptions were made months ago by the executive team and no longer reflect the present business environment. As a result, the budget can only be used as a target to reach but nothing more. For most companies there are no other enterprise-wide practices in place to support the depth and breadth of cause-and-effect impact that’s needed to fully appreciate the consequences of each decision a business manager makes throughout the business year. A forecast implemented properly can solve this need.
First of all, a forecast done right is completely different from a budget. A forecast lacks any target setting to influence its results. A forecast is a bottom-up process where the business is provides honest feedback about how the future will most likely look. Instead of these isolated, disconnected hierarchical rollups that the budget has in place for functional areas of the business like marketing, production, procurement, finance, etc. with no cross-departmental cause-and-effect linkages between them, the forecast aligns these entities where cross-functional effects are exposed so that the full breadth and consequences of each decision or scenario can be debated and discussed by all effected parties. Decisions aren’t made in isolation. Here’s an example of what I mean:
A consumer products company was at the time it completed its 2012 budget in November, 2011 planning a significant product launch in August, 2012. As a result, the entire company including the design team and Production, Distribution, Procurement, and Finance targeted that particular date for the launch and the related actions required of them to support this launch. However, over the first few months of 2012, the design team ran into some major challenges in the product development process indefinitely pushing the launch date out. This was unexpected. Production, distribution, procurement, and finance are now in a pickle. Chaos ensures. Budgets are of course out of whack. Beyond knowing that the budgeted targets are now out of alignment with the reality there’s really no other use for the budget unto itself. Now, Marketing isn’t sure what to do about its campaign plans and the related expenditures that were in place for the original August, 2012 launch date. Distribution and Production are in an equally unenviable position while Finance is ‘losing its religion’ because the cash flow consequences are monumental since the company’s betting the ranch on this launch. To make matters worse, Procurement is in a tizzy because they’ve secured supplier agreements from a number of vendors that were going to supply certain components of the product which may mean some of those components are no longer needed or new ones will be required.
This would be armageddon for most companies because they don’t have a viable communication mechanism in place to do a full cause-and-effect scenario planning which communicates to each of these functional areas what the ramifications are, including financial effects, involving each group within the forecasting system – not in isolation or via email or in an Excel spreadsheet which only finance has visibility into. Each day each one of these departments is learning new information that can be updated in the forecast for all to see keeping everyone aligned throughout this process. This is forecasting.
Forecasting, as was played out in the preceding scenario, intends to streamline all of the steps (and missteps!) required by a company to execute decisions and strategy supporting initiatives giving all of those departments and individuals involved an understanding of the financial effects of each decision. Communication and collaboration are required throughout the decision making process which would also be facilitated through the forecasting tool. The coordination of up to date information and scenario planning in response to changing business conditions is one of the tried-and-true purposes of forecasting. Forecasting gets departments and functions thinking more cross-functionally about the cross-company effects of making one decision over another and how each group is impacted. It gets everyone understanding the full impact of the decisions that may be made BEFORE they’re made. Then the real debate can take place to determine the best course of action for the entire business, not just a single department.
By Tim O’Bryan, from: http://ibm-business-analytics.com/2012/03/27/all-plan-are-great-until-the-first-shot-is-fired-why-budgeting-alone-isnt-enough-to-manage-the-business/