Most companies find budgeting a formidable challenge even under stable conditions. Managers often spend significant amounts of time on it, only to be dismayed by how little value comes from four to six months’ effort. Under volatile conditions, when economic forecasts change from week to week, developing one reliable budget to coordinate business units and track performance for an entire fiscal year is very difficult. Following the traditional budget process may even be unproductive.
There’s no easy fix, particularly for very large corporations, and companies that have tried to solve the problem don’t have much of a track record. Executives can, however, take several measures to make the process more effective: for instance, scenario planning, zero-based budgeting, rolling forecasts, and quarterly budgeting. Central to all of them is a substantial increase in the CFO’s role and a radical speeding up of the budgeting process.
For many companies, allocating or withholding resources quickly and efficiently may be the only way to navigate today’s very tough environment. A completely new approach to the budget process is often needed. The list that follows isn’t exhaustive, nor are the activities on it mutually exclusive. In some combination—depending on the business, size, complexity, and culture of the organization involved—they can help companies improve the budget process.
1. Scenario planning with trigger events
In more stable times, the budget process is typically an exercise in consensus building—a lengthy and difficult effort to generate a single view of the future to guide a company’s investments and rewards over the coming year. While many management teams speculate informally on how their businesses will evolve, few actively debate a number of scenarios or undertake the concrete short- and long-term financial analyses that would make such a debate meaningful. The process therefore isn’t agile enough to respond to sudden, dramatic changes in the economy. Any revisions to the budget as the year unfolds are reactive and backward focused rather than reflecting an informed view of alternative future scenarios.
Executives at some forward-thinking companies, however, have not only formally developed concrete macroeconomic and business scenarios, including some considered extreme,1 but also modeled the implications of each scenario for their own businesses and customers, as well as for competitors. At the end of the process, these companies adopted a single budget, but they supplemented it with concrete alternative financial statements and business plans based on plausible future scenarios. This approach lets companies build flexibility into their cost structures—for instance, through the outsourcing of services or the use of contingent purchasing contracts—so they can more easily shift from the primary budget if necessary.
Furthermore, these companies have also identified the handful of events—say, a change in the availability of short-term funding, the bankruptcy of major customers or suppliers, or a specific market share decline—that would trigger a shift from the primary scenario to an alternative. CFOs and the finance function monitor these trigger points and stand ready to alert the executive team if risk levels breach well-defined thresholds. The entire executive team would then immediately implement the predetermined contingency plans.
At one global health care products company, for example, executives monitor sales of specific premium product lines, a key indicator of the future course of revenues and profitability. When the executives saw that customers were buying fewer premium products and greater numbers of basic ones—or none at all—they shifted to a different budget and withheld part of the company’s planned second-half 2009 spending until the first-quarter numbers were clear. This company is actually growing and doing quite well, but when its trigger points suggested weakness in a key indicator, executives quickly adapted their approach to resources and investments for the rest of the year.
It’s important to note that the CFO need not apply contingency plans to the whole organization; changes can be limited to specific business units, while others continue to implement the current budget. Managers of the affected units must then develop and apply new budgets and incentives and reconsider hedging strategies, capital allocations, and funding.
- To read the full article on The McKinsey Quarterly, click here »
