5 Indicators Your Company Needs A Finance Transformation – Annual Budget Cycle Times (Part 3 Of 5)
This is the third in a 5-part series of articles that will help you identify if your company needs a Finance Transformation.
The length of time it takes from the kick-off to the budgeting process to final approval reflects the efficiency of the Budget process and, as we all know, time is money. A faster Budget cycle puts less strain on human resources, systems and operating units giving them more time to focus on growing and improving the business instead of debating the measure at which their performance will be judged.
One of the biggest causes of the frustration of the annual budgeting process is confusion as to what it is and what it is meant to do. To get past this hurdle it is best to define what a Budget is, and is not, in comparison to several other common financial planning terms.
What Exactly is a Budget Anyways?
“There are a good many of them, to be sure–but “delivering the budget” has got to be one of the most universally entrenched, uniquely counterproductive exercises in organizations across the world.”
Jack Welch
People have been calling for the death of budgeting for decades, but it lingers on and for good reason. In my last post, I discussed the difference between a Financial Forecast and a prediction. In this post, I will continue the narrative by defining what a Budget is in comparison to other common terms that are frequently misused when defining a Budget.
- A Budget is the allocation of money to different activities or actions by which a Company has committed itself. It is used to control costs and avoid scope creep.
- A Financial Forecast is an analysis of where you think a Company is headed based on a series of assumptions. Typically portrayed in a financial model(s) that depict results of operations over a specified time frame.
- An Objective (can also be called Target) is a description of where you would like the Company to end up. For example, $5 Billion in 5-years. It gives no detail as to how a Company would achieve such an objective.
- A Plan is what a Company would like to happen portrayed over time in a financial analysis taking into account various actions, typically, to reach an Objective/Target.
The Budget process can be considered a control mechanism by which funds are allocated to meet desired organizational goals. The budget process may begin as early as June and last well into the next year.
How Long Should a Good Annual Budget Process Take?
A key driver of Budget cycle time is the number of budget iterations. According to APQC 1, leading organizations produce no more than 4 iterations, while slower organizations churn out 8 or more iterations before approving a final version. The median number of budget iterations in APQC’s study was 5 iterations.
Performing all these Budget iterations takes time. In a separate study, APQC tracked annual Budget cycle times2. This study showed leading companies were able to complete the entire process in 25 days or less. Bottom performers need 56 days or more to complete the same process with a median of 32 days for all organizations in the study.
Why Does the Annual Budget Require So Many Iterations?
Frequently, Budgets are negotiated agreements by which acceptable levels of performance are codified between departments, business units and, depending on the industry, suppliers, and customers. The time it takes to complete each iteration is multiplied by the number of levels the Budget needs to pass through before final approval (E.g.: department, division, senior executive, Board, etc…)
Just like Financial Forecasts, Budgets try to predict the future in an uncertain world. To do this they must use assumptions. Many assumptions go undocumented. Whether explicit or implied these assumptions need to be baked into each Budget iteration and, due to the lack of documentation, frequently change between iterations causing confusion and delays.
To learn about the foundational elements of creating a plan/budget visit Business Planning I: Introduction to Planning
Adding to the complexity is the desire of Boards and investors to hold Company Management accountable to the annual Budget. This makes the entire process a high-stakes game of chicken where Management wants to present conservative numbers to ensure better performance, while Boards and investors argue for higher growth and profits. At the time of determination (typically after the end of the fiscal year), neither party recounts what their initial assumptions were and whether they came to fruition. For example, did GDP grow at X% rate or commodity prices increase? When a Budget is beaten, everyone decries that their cunning wit and skill is what made that possible, while Budget misses are lauded as bad luck caused by poor assumptions.
Why is Annual Budget Cycle Time Important?
Budget cycle time is a proxy for well-documented policies and procedures that minimize the political wrangling that goes with the annual Budget cycle. An annual Budget Cycle that is more than 60 days and exceeds 5 rounds of revisions may indicate that the organization needs a Finance Transformation.
1 Metric of the Month: Number of Budget Versions
2 Metric of the Month: Annual Budget Cycle Times
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