Save content
Have you found this content useful? Use the button above to save it to your profile.
AIA

Why traditional budgeting can't cope with re-forecasts

by
18th Jun 2006
Save content
Have you found this content useful? Use the button above to save it to your profile.

Many organisations want to streamline their budgeting process; some want to eliminate it completely. Regardless of what the endgame might be, producing more frequent re-forecasts is typically part of the solution. Richard Barrett of ALG offers some advice.

The word that inevitably crops up whenever more frequent re-forecasting is discussed is "rolling", and many organisations use some form of re-forecasting today. For the most part this is either budget contributors making rough estimates of revenues and expenses in the out years ("Budget Year +1", "Budget Year +2" etc), or a senior member of the finance team re-forecasting summary revenues and expenses for the months to go until year end, based on year-to-date variances against budget.

While this type of high-level rolling re-forecast will undoubtedly help to forewarn the executive of the likelihood of underachieving budget, it does not provide insight into why variances have arisen or what actions need to be taken to address them.

For an organisation to be constantly adaptive and capable of aligning capacity with demand, re-forecasts need to go beyond the finance function and involve key operational managers. Re-forecasts also need to be more frequent and research shows that for many organisations this means bottom-up, enterprise-wide rolling re-forecasts.

The budgeting process in most organisations may include the collection of some non-financial data such as sales units, headcount or full time equivalents (FTEs), but generally the focus of the exercise is line item expenses.

To generate their line item expenses, contributors will typically work off-line on spreadsheets, first forecasting the demand on their department and then modelling the amount of resource required and the cost of that resource.

Request a bottom-up, enterprise-wide re-forecast and most contributors will update and recalculate their resource planning spreadsheet, then re-key the resulting line item expenses into the enterprise budgeting application. Little wonder the exercise is so time-consuming and costly.

Whereas the traditional budgeting process is hierarchical with the focus being to collect and consolidate individual contributions to produce the enterprise profit and loss account, when managers are generating their departmental budgets, they are modelling the causal relationships that are running horizontally across an organisation: the operational drivers.

When asked to produce a budget or a re-forecast, their first concern is that the department upstream of them provides them with a reliable forecast of future demand. In fact, until they have received this, they cannot start their own departmental planning.

Sometimes called "consumption-based" planning and budgeting or "resource consumption analysis", driver-based planning and budgeting has the following characteristics:

  • Non-financial driver data is used to model financial data, which could include quantitative measures of demand such as the number of telephone enquiries received or measures of the input required to produce a unit of output.
  • Quantification of any assumptions or rules of thumb.
  • Drivers run horizontally across organisations. Simply preparing and simultaneously distributing schedules to every contributor will not enable driver-based budgeting.
  • Drivers span time periods. Many key drivers of financial performance such as customer attrition rate need modelling over time in order to forecast future demand and ultimately financial performance.

By incorporating non-financial measures and modelling them over time, driver based-budgeting makes it possible to use "leading" indicators to predict the "lagging" financial results. Adopting this approach will inevitably lead towards rolling re-forecasts as organisations realise the superficiality of the traditional 12-month planning and budgeting timescale.

About the author
Richard Barrett is the vice president of marketing at ALG Software. This piece is an extract from the company's whitepaper, 'Driver-Based Budgeting: The proven route to faster budgeting and more frequent re-forecasts', which is available as a download (200kb PDF) from the ALG website.

Replies (0)

Please login or register to join the discussion.

There are currently no replies, be the first to post a reply.