Budgeting is an essential process for every organisation and it serves three important functions. First, it sets the targets for the coming year. Second, it provides a basis on which to monitor performance at the individual and company level. Third, it enables the organisation to reward its employees relative to their achievement of these targets.
Your budgeting process is broken
Despite being critical to business success, the budgeting process at many companies requires improvement. There are four major reasons for the present state of budgeting at India Inc.:
Firstly, budgeting at most companies is anchored in the past. What this means is that the budget for the coming year is usually an incremental revision of last year’s numbers. Such anchoring is a common cognitive bias that leads us to become over-reliant on one piece of information - usually the first piece - when making decisions. As the process typically starts with a review of the previous year’s results, subsequent discussions tend to circle around these numbers.
The second flaw in the budgeting process is the tendency for it to turn into a gaming exercise between senior management and department heads. As a result, budgeting often becomes an exercise in developing targets that are acceptable rather than achievable.
For example, heads of department may accept unattainable targets to satisfy their senior management’s top line goals, in full expectation that they will not be achieved. Conversely, senior management may accept low-ball targets from their teams which under-estimate the real business potential and are easily surpassed.
At one company we worked with one division had achieved 100% of its previous year’s target while another division was languishing at only 30%. However, after closer scrutiny, we found that the divergent performance was largely related to the very different ways in which their targets were set.
The third gap in budgeting is the disconnect between the process and the current market reality. In today’s fast-moving environment, rapidly changing customer behaviour and new competitive threats are disrupting many of the assumptions that have been built into the budgeting process over the years. As a consequence, budgets are increasingly out of step with the latest market developments.
The final break in today’s budgeting process is its lack of agility. Budgets are set in stone at the beginning of the year and targets are cascaded down through the organisation accordingly. Therefore changing course in response to new circumstances is like turning around an oil tanker. Furthermore, as employee rewards are linked to these annual targets, there is little incentive for individuals to rock the boat by taking initiative and re-directing their efforts mid-course.
Many Indian companies experienced the most dramatic example of the need for budget revisions during the demonetisation shock of 2016 which saw sales slump as much as 30-50% during the affected months.
Given these four dysfunctions in the current process, there is a clear need for companies to take a fresh look before repeating the same mistakes in this year’s budgeting exercise.
Take these 5 steps to better budgeting
Companies can make this year’s budgeting process relevant in today’s changing world by following five steps to better budgeting.
1. Refresh your market view
Firstly, with the market landscape undergoing rapid change, businesses must reset the assumptions on which their budget is based. This can be achieved by having the market discussion up front in the budgeting process. The objective should be to create an accurate picture of how your customers’ needs have changed and what the latest competitive threats are.
Take for example the process of digitalisation that is rapidly changing customer behaviour and competitive dynamics in India. The Government of India recently introduced an e-marketplace which promises to transform the procurement process for all companies selling into the public sector. This will introduce price discovery, greater transparency, and potentially new types of players who might have struggled to tap the Government market in the past. Any company currently selling into this space or considering it will need to put this development at the heart of their discussions and future planning.