Beyond Budgeting - A New Approach to Annual Budgets

 


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In their book, Beyond Budgeting, Jeremy Hope and Robin Fraser highlight the inadequacy of traditional annual based budgeting and argue passionately for a new management model that can cope with the volatility of today's business environment. Their model embraces much more than just budgeting, it is more a philosophy of decentralization and a way of encouraging managers at all levels to become accountable for their performance without tying them to an annual budget straitjacket.

Hope and Fraser analysed many companies of various types that have abandoned traditional annual budgeting in favour of their new model and found that management gained a new sense of empowerment and a “can do" attitude. In addition, they benefited from faster and more adaptive decision-making, reduced bureaucracy and lower costs. The companies became more competitive and customer satisfaction improved along with many of the company's’ KPI’s (Key Performance Indicators).

The new model replaces annual budgeting and centralized control systems with multilevel controls that include effective governance, fast financial actuals, trend analysis, rolling forecasts, key performance indicators, performance ranking, and management by exception.

Its probably no surprise that annual budgeting is expensive and time consuming, but just how much time companies are spending on the process and how useful are the results, should be of concern to all senior executives. Hope and Fraser found that the budget process typically starts at least four months prior to the year to which it relates and grinds its way through countless meetings where managers negotiate targets and resources. An estimate of 20 to 30 percent of senior executives’ and financial managers’ time is absorbed in the process, while the Ford Motor Company concluded that they spend $1.2 billion per year on forecasting and budgeting.

Quite apart from the cost, the budgets this process produces are often meaningless. The forecast numbers are out of date before the budgeting round has finished. Even the numbers themselves are suspect. Having been agreed upon during countless negotiations, they are based more on politics than strategy. A manager’s performance is often related to achieving targets set out in the annual budget, which inevitably leads to a conflict of interest. Managers will attempt to negotiate the lowest possible targets and avoid taking risks.

Without going into the whole management philosophy, which is covered in commendable detail in their book, the control systems clearly needed in today’s volatile world must be fast and flexible to be relevant. In the companies that successfully implemented their model, Hope and Fraser say: “All our case examples use rolling forecasts in one form or another to provide a fast, high-level view of future performance”.

For more information on rolling forecasts and budgeting visit http://www.markitquest.com

About the Author: Mark Ritsema is the founder of Markitquest, developers of the Controller Series; a set of Excel based financial modelling software tools for business. Mark has over 20 years experience in financial management, having worked in various industries as Controller and Financial Director for companies both large and small.

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