Robert Kugel's Analyst Perspectives

Budget season is about to open at most companies that operate on a calendar year, so this is probably as good a time as any to rethink the process. Almost all companies will undertake the construction of a budget this year the same way they did it last year, despite widespread complaints that it is a monumental waste of time. One major reason why budgeting never changes is that it isn’t important enough to be worth serious rethinking. Another reason is that too many vested interests are aligned with the status quo, especially because compensation is tied to budgets. Despite this, I think companies can do better, evolving the process from a finance-centric activity to one that serves the needs of broader business interests as well. Planning and budgeting are core pieces of performance management. They establish baselines to measure and monitor how well a company is doing. Businesses should integrate operational and financial planning to achieve greater forecast accuracy, improve strategic alignment and fatten their bottom line. The objectives can (and should) be aligned with a company’s strategy. Yet, outside of the finance department, one common criticism of planning and budgeting is that it is finance-centric. For many companies, this is undoubtedly true; the main purpose of the process is to set a budget for expenses based on assumed revenues, so it’s no surprise that the focus is on the dollars, euros, yen and pounds and not the production volumes, pallets and tank cars of raw materials, marketing promotions and other activities that drive the revenue and expense items that make up the budget. Therefore it’s also no surprise that too many people who do not work in finance departments equate performance management with financial budgeting. While a company’s budget is one of its major forward-looking documents, it is only one of many plans that coexist across business units. Sales departments have sales forecasts, and those that sell direct often use a disciplined sales funnel approach to do a bottoms-up projection of when specific transactions will close. Manufacturing organizations use demand plans to drive forecasts for their raw materials and purchased parts needs, schedule their equipment and maintenance, and so on. Companies with logistics chains project inventory levels and transportation requirements. Within any department there may be dozens of plans or forecasts, usually kept on desktop spreadsheets. Our research finds that connections between these various forward-looking activities are limited. Although companies are not completely uncoordinated, gaps routinely occur – “manufacturing never knows what promotions marketing is planning until it’s too late” is a common complaint. The impact is rarely disastrous, but the lapses create needless costs and diminish effectiveness. For companies that want to do better than the status quo, we advise two basic courses of action. One is to increase the integration of the various plans and forecasts that exist in your company. Such a change can be implemented as a big-bang transformation or incrementally. Ventana Research’s integrated business planning benchmark research shows that a large majority of companies have a limited ability to integrate their financial budgeting, sales forecasting, operations planning and demand planning functions. Moreover, although usually the budget and other forward-looking processes align at the time the annual budget is put together, the operational forecasts and plans are more dynamic than the financial budget. They often are updated weekly or monthly, while budgets typically are done annually, and a much less detailed reforecast is done quarterly (although in some companies this may be monthly). In addition, we find that the exchange of information outside the annual budgeting process is hit and miss. For example, even when companies institute a formal sales and operations planning process, they rarely involve all the key managers and executives. This lack of coordination leads to shortfalls in performance, partly because the left hand doesn’t know what the right hand is doing, and because various parts of a company are unable to coordinate their actions when major changes occur in the business or its markets. A second, more ambitious approach is to increase the degree to which your company attempts to optimize the long-term bottom-line impact of its sales and operations decisions by assessing the financial implications of different courses of action. This assessment is far from simple because the complex interactions between operational elements – sales, distribution, production, capital investments and tax planning, to name a few – almost always make it difficult to manage to a common set of goals across the enterprise. Our research shows that companies tend to concentrate on solving only one or two problems, such as sales performance, capital planning or budgeting. Often, implementing these operational strategies becomes inefficient and prone to errors because managers lack the ability to understand the consequences that each possible decision imposes on others. Consequently they routinely make tactical decisions that have a negative effect on the enterprise’s strategic financial goals and objectives. Software plays an important role in facilitating and supporting a more coordinated approach to the forward-looking activities throughout the year. A more explicit and integrated approach to planning – not just budgeting – can improve how well a company performs and enhance its agility in responding to change. For any midsize or large company, software is a critical part of any attempt to optimize the financial impact of operating decisions, because individuals rarely are capable of understanding the scope of the tradeoffs that must be considered, let alone calculating the implications. Yet, although software is important, the most important first step is to decide to change the annual budgeting process to make it a more useful and comprehensive management tool. Regards, Robert Kugel – SVP Research

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