Budgeting & Forecasting in the Age of Uncertainty
The past couple years that have been assailed by the COVID-19 pandemic have unleashed a plethora of employee-safety and economic shocks. Time and the demands of putting together a budget for the year to come have put even more pressure on all executives, especially finance leaders. After a long period of improvising, CFOs recognize that they need real budgets for 2022 to align resources with strategy. But they also understand that typical budgeting methods, with traditional inputs and standard approaches, are no longer suitable for this era. To illustrate further: 43 percent of the 127 CFO respondents in a recent McKinsey consulting survey expressed the need to streamline their budgeting processes to improve efficiency and reactivity. Meanwhile, 65 percent anticipate more use of rolling forecasts in 2021 and beyond. Four steps that CFOs can take immediately to reinvent and improve their budgeting processes for 2022 are as follows:
Improve strategy and adopt “Beyond Budgeting”
Gravitate towards increased use of rolling forecasts vs. traditional budgeting
Implement new technologies
Hire and reskill finance teams
Adopting Beyond Budgeting
An overwhelming majority of organizations still depend on traditional organizational designs characterized by hierarchical structures and navigation via budgets. But these processes are outdated, significantly impairing a company's ability to act and respond in rapidly-changing environments. A difficult corporate context like this raises the question of how organizations can effectively conduct budgeting in an age of uncertainty. Among the solutions to this issue, is the adoption of the “beyond budgeting” strategy.
Beyond Budgeting has often been defined as a financial concept, comparable with methods like Better Budgeting. However, this perspective is inaccurate and shortsighted. Beyond Budgeting is a holistic organizational outlook. At its core lies an agile approach based on self-organization. Beyond Budgeting is composed of two interlinked, coherent key dimensions: decentralized leadership and adaptive management processes, each comprising six principles. As a holistic approach, Beyond Budgeting consistently offers an alternative to the inherently rigid and bureaucratic budget-based management processes (also called budgetary control). Without tackling these processes, a sustainable transformation to an agile organization is unrealistic.
In most companies, a budget represents financial planning and goal data at the same time. Budgets, therefore, have a dual nature, addressing both means (planning) and ends (goals) simultaneously. This is the overarching design problem of budgetary control: planning figures become goal figures, which is often referred to as a phenomenon called “displacement of goals”. The issue here is the perversion of means and ends. To exacerbate such issues further, the means side of budgets involves several different planning functions, such as forecasting, resource allocation, and reference for the incentives plan. Hence, this multiple coupling of different things into one number further exacerbates the dysfunctionalities of the displacement of goals. It commonly leads to absurd and time-consuming negotiation games; demotivating alibi exercises, wasting resources to be on the safe side; transferring revenues to other closing periods, and number crunching to maximize incentivized bonuses. It is sometimes thought that such budgets support control. But these dysfunctionalities demonstrate that they only produce the illusion of control.
Rolling Forecasts in Place of Traditional Budgeting
In business environments, a common misconception is that a forecast (or budget, for that matter) is a prophecy: a prediction of exactly what will happen. When rolling forecast concepts are used, the new forecast data, therefore, become binding expectations, which themselves become a control standard. This essentially means that the forecasts have mistakenly been interpreted as goals. The same perversion of means and ends discussed earlier occurs with forecasts and budgets. This undermines the critical intent of forecasting entirely: to generate progressive thinking and act in uncertain, volatile times in the corporate world.
A forecast aims to provide an unbiased assessment of future reality. The results of a forecast include the effects of assumptions on the external environment and the consequences of previously made decisions. If a forecast shows that the targeted aim is in danger or that new chances have arisen, decisions on additional possible actions must be made. These decisions must then be integrated instantly into the forecasting cycle, resulting in a new forecast. Due to new insights and actions to be initialized, the present forecast can change in the next forecasting cycle. One forecasting cycle follows another, continuously integrating the newest insights and actions.
Unfortunately, many companies are resistant to move away from traditional forecasting methods. The emphasis Wall Street places on quarterly earnings motivates organizations to stick with traditional budgeting/forecasting.
When companies do decide to start using rolling forecasts, they face a few additional challenges. Preparing to start using rolling forecasts can cost time and money if your forecast process isn’t already automated. Accountants will need more training, and their workload will probably increase if they’re doing constant forecasting throughout the year. Your organizations will also need to figure out how to evaluate performance, since it won’t be looked at during one specified time every year. Fortunately, there are tools to help automate your processes in rolling forecasts.
Rehire and/or Reskill the Workforce
Given the aforementioned criticality of implementing new strategies (and further developing the level of their use via new technologies), reskilling, and even rehiring finance team members will prove to be a critical step in improving budgeting and forecasting. The criticality of a reskilled workforce in a high tech landscape was well described by Deanna Mulligan, retired CEO and chair of Guardian mutual insurer, in her book “Hire Purpose: How Smart Companies Can Close the Skills Gap”. According to Mulligan, the role of the CFO is particularly important in this context; as organizational leaders, they have the power to demonstrate the value of reskilling their own finance talent. Additionally, they are able to champion the business case for workforce development policies. CFOs can take the learning and development budget and direct it towards retraining for improved, tech savvy budgeting/forecasting skills for changing job responsibilities.