Lots of companies talk about moving to driver-based budgeting or forecasting, but few actually make the leap. Why is it so hard to move away from traditional budgeting and forecasting models? What value is ultimately obtained by making this dramatic change?
For most companies, the traditional annual budgeting process is long and tedious. Top-down guidance is created and communicated during the summer, followed by bottoms up estimates put together and consolidated into late fall. Then final numbers are agreed to with the bottoms up numbers rolled up to match. If you are lucky budgets for the following year are locked down and finalized prior to year-end, but for many companies, this does not occur until Jan/Feb of the current year.
And every year you make notes about what went well, what did not and what you can do to make it easy and more efficient next year. Every year you enhance and refine excel models, you improve assumptions documentation, you simplify the process for consolidating information. And yet the incremental improvements don’t seem to improve the accuracy, or the overall effort required to complete the budget.
If this sounds at all familiar maybe a move to driver-based budgeting is right for you. And you may be closer than you think.
Begin the Budget Process
When you begin the budget process, you typically establish the initial top-down numbers thru applying certain communicated strategic objectives:
- % increase in sales
- % increase in margin and/or price
- % change in direct/indirect procurement
- % salary increases
- % change in employee benefits
- % travel and expense as a sales
- SG&A as a % sales
- % Productivity improvement
You take these assumptions, run some calculations and generate the initial top-down numbers as well as incorporate everything into your published budgeting guidance. In traditional budgeting, an organization plugs their sales & expense numbers to whatever is agreed to and then build in commentary regarding how they are going to get there. When the actuals come in the variance to budget is easy to calculate, but again the explanations exist outside of the system. Everyone has similar industry-specific walks to explain variances, but these are again generally very high level like mix, volume, or price with written explanations. The art in traditional budget/actual variance analysis is remembering the different story lines from budgeting, to YTD or QTD.
Driver-based budgeting allows you to begin to get away from the written explanation and let your data tell more of the story. Over time you gain better insight into the relationships between various parts of your business and how elastic/inelastic various drivers actually are. This, in turn, helps improve the quality and speed of business decisions.
Everyone makes this sound easy. The concepts are simple – you can rattle off the top 10 business drivers in your sleep, but the execution is not. For complicated organizations excel will no longer be a viable option as the models are too complicated. And it is always a challenge to identify the “vital few” drivers to work with and then how detailed to make them. And you need to remain flexible, modifying/removing/adding drivers as the business environment changes and as you gain better insight into what levers truly matter.
What to Consider
So if it is complicated and Excel is no longer a viable option – why should I even consider it?
- Eliminate non-value added work. With traditional budgeting, you often end up planning at a level not really needed. Do your finance people plan office supplies at the departmental level? If a department is widely off in this category, will it ultimately make a significant difference? How many other categories of the business are like this? How much time is spent developing and preparing detail no one ever really uses.
- Accelerate month-end financial & variance analysis. Once you have your driver based models developed you can then bring your actuals into them. These models should be designed around the “key drivers” of your business. This structures your financial data around these drivers making understanding the information and communicating it much easier.
- Going beyond the what and moving directly to the why. Traditional budgeting brings the budget to the actuals. The problem this creates is it allows whoever is doing the analysis to create whatever story they believe they can sell. A driver-based budget provides greater visibility to the truth of the story. Do the facts really match the assumptions? It is one thing to have a EBIT walk that identifies the miss being primarily driven by volume. With comments such as, “Volumes on product XYZ were lower than expected. This was partially offset by an increase in the lower margin product ABC”. A driver-based budget scheme could have these details by product line in terms of volume, sales and price as table/chart driven output. No comments necessary with no place to hide.
- Organizational flexibility. With traditional budgeting, we tend to get locked into fixed numbers. Your salary number must be “X”. This then tends to live in isolation. Driver-based budgeting can provide for greater accountability and flexibility. As the business environment changes these would be reflected in the drivers. If you have a driver that indicates the optimum number of customers per sales rep is 50 then if you have an opportunity to expand into a new market with 150 new customers. This can all roll thru and be reflected appropriately allowing for the relationships between the information to be understood and hopefully allow the business to react more quickly to changing information.
If all this sounds like the right direction to head and you want to know more, we have the experience to assess how to get started.
Download our free eBook and learn how to set your course right with rolling forecasts. Dramatically reduce the time your business spends laboring over the annual plan or budget so that your assumptions are current and in line with actual market conditions.
We’ll guide you through some of the most important best practices as well as advise you on steps to making rolling forecasts a success in your organization.