Stop Wasting Your Time On Annual Budgeting

Joost
Written by in Practices

Many of us are familiar with the performance targets and budgeting cycles used by traditional companies. Do you recall targets like double sales, increase market share and reduce cost? Every year? Most organizations are still driven by top-down targets, rather than a clearly stated purpose.

But more progressive organizations realize these tedious processes are out of date. They don’t believe they add enough value. Some have stopped using them altogether, and now focus their efforts more productively.

Why stop?

They promote unhealthy behaviors

We all know at least one stupid behaviour that results from annual budgeting. People order all kind of crap at the end of the year just to make sure their allotment is fully spent: not because it is really needed, but because they want to secure at least the same amount next year!

You also know that departments typically ask for more resources in every budget cycle. And you must have heard of managers who encourage their team to push new projects into next financial year—not because they don’t want to perform but because they are afraid of ending up with even tougher targets next year.

These are some of the unhealthy behaviours that fixed targets and budgeting processes promote. Instead of employees acting on common sense, they are encouraged to make decisions based on irrational reasoning. There is even a name for it: ‘managing by the numbers’.

We experienced it in our corporate jobs. If we had already made our numbers, projects almost sold were delayed to ensure they would be booked in next financial year. Even if we didn’t make our targets, it was sometimes better to delay projects to make next year easier because “We aren’t going to make this year’s target anyway.”

We also experienced the childish “let’s-spend-every-dime-of-our-budget” mindset. Extremely expensive equipment was bought at the end of the year to make sure our budget wouldn’t be reduced next year. The result? New and expensive equipment arrived every year, and only gathered dust.

They slow down the organization

Target setting and budgeting processes require their own bureaucracy. This makes them even more time-consuming and reinforces the barriers between leaders and employees.

The combined effect is to slow things down. Managers need to constantly measure, report, present, explain and negotiate. All of this gets in the way of attempts to be more ‘agile’, ‘adaptive’, or ‘responsive’. It is more difficult to do this within a system of fixed targets, plans and resource allocations.

They are expensive

Annual budgets are so ingrained that some organizations cannot imagine living without them. The process is a highlight on the corporate calendar. It requires resources. It encourages numbers games. It absorbs huge amounts of employee time.

First, top management wrestles with defining strategic directions and high-level goals. Next, cascading these into the subsequent budgeting processes is not an easy task either. Finally, after countless meetings and awkward negotiations, things are finally agreed upon. What an effort!

[clickToTweet tweet="Ford once estimated that their planning and budgeting process cost them $1.2 billion a year." quote="Ford once estimated that their planning and budgeting process cost them $1.2 billion a year."]

It should come as no surprise that this process is extremely expensive. The Ford Motor Company, for example, once estimated that their whole planning and budgeting process cost about $1.2 billion a year. That’s a lot of money. Is it worth it to divert all this time away from improving products and services? Progressive organizations don’t think so.

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What to do instead?

Progressive organizations set targets with a fast and robust process. They take just a few days, not months—and the targets, once set, seldom need to be changed. They replace the fixed processes with flexible and relative measurements—all under peer control. Time spent on annual budgeting can now be used to get real work done. But, specifically, how do they do it?

Establish purpose, values and principles

Teams are trusted to manage their own business within agreed boundaries and clear guidelines. Engaged employees, motivated by inspiring purpose, commit themselves to a set of values and principles. These drive the organization; not annual targets and budgets.

Make it everyone's responsibility

Setting and meeting goals should be the responsibility of everyone in the organization, and done in an atmosphere of self-regulation and trust. In progressive organizations teams are trusted to set their own targets and are held fully accountable for their results.

It should not be a surprise that teams set more ambitious goals than their managers would. So, let teams set their goals. Allow the process to be a way to imagine, and aim for, best possible futures.

Evaluate the relative performance

But don’t evaluate and reward teams on dreaming and guessing. Evaluate and reward them on how they perform relative to previous years, and relative to the competition. It will stimulate them to look beyond their own responsibilities, and build trust in their own judgement.

Progressive organizations use prior year results as a first measure of performance. It’s their minimum expectation. Then, performance is first compared internally (with other teams), and then externally (with direct competitors).

Transparent and open control mechanisms 

Progressive organizations use technology to share the performance data of all teams in a transparent manner. The technology can inform everyone in the organization, at all levels, about collective and team performance. Some establish internal performance tables, based on regions, products, services, branches, or customers. All this encourages low performers to search for new ways to improve their outcomes.

Different budgeting in practice

At French manufacturing company and Bucket List pioneer FAVI, they tossed away continuous budget comparisons. Instead, they make a rough monthly forecast of their sales and costs for the year to come. Based on this estimate, they can place orders for raw materials in advance. Afterwards, they don’t compare the budget versus the actuals on a monthly basis.

Let's finally stop encouraging the childish 'let's-spend-every-dime-of-our-budget' mindset.

click to tweet

Instead, teams track their monthly numbers and take action only if they are unsatisfactory compared to last month or last year. They say: “In the new way of thinking, we aim to make money without knowing how we do it, as opposed to the old way of losing money knowing exactly how we lost it.” Luckily for them, FAVI does not need to report to outside shareholders, as they are privately owned.

Joost
Written by Joost
1 year ago

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Replies (1)

Tom

Tom

In principle this makes some sense.. the FAVI example is a useful one though - it raises the question for me: how can this stuff be applied to much larger businesses that do have shareholders and other governance demands on them? Thanks for the post.

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