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Budgets: All Bad Things Must Come


to an End
Dominic Paniccia

J
ack Welch, the leg- • Issue #2: They’re
endary former CEO Jack Welch, the legendary former General Electric not driver-based—
of General Electric, CEO, once said, “The budget is the bane of corpo- The budgets are
once commented, “The rate America.” Many people dread preparing built based on tar-
budget is the bane of annual budgets. Why is the budgeting process gets and historical
corporate America.” broken—and what can we do about it? performance and
Welch’s sentiment is © 2008 Wiley Periodicals, Inc. are generally not
one that is shared by influenced or
many people and often informed by exter-
includes those involved with or and attempts to project the nal factors or cur-
“mired” in the budgeting future by aggregating the rent market condi-
process. As we approach the budgets of business divisions, tions. Additionally,
final months of the year, individ- geographic markets, and so on because they are
uals are beginning to prepare for to arrive at an enterprise-level based on past
their company’s annual budget- budget. The pitfalls of this results and not
ing process. With this prepara- traditional budgeting approach predicated on
tion comes a degree of dread as are numerous, including: driver-based mod-
they consider the time, resources, els, it is impossible
and logistical or technical chal- • Issue #1: Budgets are nego- to understand the
lenges often involved. Part of tiations—In the budgeting implications on
this dread also comes from the process, units or markets performance from
fact that people are often unsure typically negotiate their tar- an increase or
of the impact or value of the gets with corporate in an decrease in the
budgets they create. effort to lowball their com- performance of
mitments for the coming any driver.
WHY DO COMPANIES BUDGET year. It is in their interest to • Issue #3: The long term is
AND WHY IS IT BROKEN? do this, as it helps them not the next 12 months—
demonstrate the best per- Budgets are generally
The typical answer to the formance for their unit, but oriented around the fiscal
questions above is to under- these low targets are not in year and fail to consider the
stand and help achieve finan- the best interest of the implications for performance
cial targets and goals. Tradi- organization, as they’re not beyond one year of actions
tional budgeting is often reflective of true, potential taken today. There is nothing
managed by a central group performance. magical about December 31

© 2008 Wiley Periodicals, Inc.


Published online in Wiley InterScience (www.interscience.wiley.com).
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26 The Journal of Corporate Accounting & Finance / November/December 2008

(if your fiscal year follows not a smart use of time or annual budget to a rolling
the calendar), and so there is effort, as it is nearly impossi- (continuous) forecasting model.
no reason for you to think of ble to deliver insight but A rolling forecast is the process
performance only until a requires significant effort. of predicting profit-and-loss
somewhat arbitrary point in • Issue #7: Every dollar of accounts for a company on a
time. expense is treated the rolling basis, with the typical
• Issue #4: Driving using the same—Traditional budgeting rolling forecast ranging between
rearview mirror—Companies is fixated on reaching rev- four and eight quarters ahead. In
spend too much time compar- enue and profit goals, with the rolling forecast, as a com-
ing their results to last year’s generally little attention paid pany completes a quarter of
budget as part of a backward to the nature of and drivers results, it then continuously
examination to understand of the expenses that drive extends its forecast to capture
what has happened. This time margins. While significant the rolling quarters that lie
would be much better spent time may be expended fore- ahead. It is also important to
looking forward and develop- casting expense minutia, note that rolling forecasts are
ing insights and plans to there is little utilization of separate from corporate revenue
tackle what they think could the budget to manage and profit targets. The use of tar-
or will happen. expenses strategically. gets will only force business
• Issue #5: When it’s done, it’s • Issue #8: The best opportu- units to build a forecast to
outdated—Because of the nities don’t get funding— achieve these targets. In such
nature and speed of business Because the targets that cor- instances, the forecast output
today, decisions and commit- porate tries to set form the becomes far removed from real-
ments made during the ity and hardly useful for
process are obsolete management to use in deci-
from the beginning. Traditional budgeting is fixated on sion making.
Given the importance reaching revenue and profit goals, Jeremy Hope, author
ascribed to the budget, of the book Beyond Bud-
people still feel a need with generally little attention paid to geting, contends, “Rolling
to manage to it even the nature of and drivers of the forecasts, if well pre-
though it is perennially expenses that drive margins. pared, form the backbone
out of touch with orga- of a new and much more
nizational reality. useful information system
• Issue #6: Detailed to a that connects all the
fault—Too often, budgets are ceiling for unit performance pieces of the organization and
made in excruciating detail— in traditional budgeting, gives senior management a
with significant time and there is no incentive for continuous picture both of the
energy expended on forecast- units to increase their tar- current position and the short
ing office supply costs, for gets. In fact, as mentioned, term outlook.”1
instance—when this detail is they will negotiate them The rolling forecast as it has
ultimately quite irrelevant to down if possible. These been articulated closes many of
company performance. This lower targets prevent the the gaps discussed with tradi-
trap of mistaking activity for organization from receiving tional budgeting, as detailed
progress is frequent with the the best investment ideas below.
budgeting exercise. People because there is no incentive
spend inordinate amounts of to outperform. Outperfor- • Solution to Issue #1: No
time forecasting those compo- mance merely creates a more lowballing—Since the
nents where they have lots of higher bar next year. forecast and corporate tar-
data and management infor- gets are separated, business
mation systems (e.g., office units are no longer encum-
supplies) and then do things IS THERE A BETTER WAY? bered with targets. This
like simply grow revenue by process ensures the units do
ascribing a growth rate to last Every year, more and more not waste a lot of time bar-
year’s revenue figure. This is firms are moving away from an gaining for lower targets and,

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The Journal of Corporate Accounting & Finance / November/December 2008 27

instead, focuses their efforts • Solution to Issue #4: It’s reduces the pain of the
on developing realistic and about future insights and not annual budget cycle, since
smart projections. It is just looking back—A rolling the “budget,” for lack of a
incumbent upon manage- forecast is focused on the better term, is always fresh.
ment to make sure the only future and answering how the • Solution to Issue #6: The
expectation in a rolling fore- organization will perform right amount of detail—This
cast is for units to deliver given the current state of the process cuts out the details
reasonable and well-con- business and latest projec- that do not drive business
structed views into the tions for business drivers. For results and that generally
future so that management is example, a manufacturing result in long, sleep-deprived
in the best position to make business would update key nights. Planning teams no
critical decisions. Manage- business drivers such as raw longer focus on how to fore-
ment should reward units for material prices and energy- cast the cost of noncore
realistic yet aggressive fore- cost projections to predict expenses (like supplies) and
casts versus rewarding them future earnings. A significant focus on what drives growth
for meeting a fixed target. change in the price of raw and profitability (e.g., rev-
• Solution to Issue #2: materials may have implica- enue and expense drivers).
Rolling forecasts are driver- tions on future production Rolling forecasts as
based—The focus in rolling planning, as the firm can pre- they’re generally articulated
forecasting is on understand- emptively shift to a product handle six of the eight pit-
ing key business falls that budgets suffer
drivers—for example, from as just discussed. The
the cost of jet fuel for It is incumbent upon management to rolling forecast does not
an airline. The forecast make sure the only expectation in a have to stop there in
models create relation- becoming a more powerful
ships between key driv- rolling forecast is for units to deliver management tool. There is
ers and financial per- reasonable and well-constructed views a significant opportunity
formance. As these for companies to leverage
drivers are updated, the into the future so that management the rolling forecasting to
forecast reflects the is in the best position to make actually combat the other
changes in financial critical decisions. two remaining pitfalls of
projections. This allows budgeting.
organizations to also • Solution to Issue #7:
perform sensitivity Some expenses are more
analyses by modifying the with lower-cost raw materials valuable than others—
key driver assumptions and or these prices can inform Expenses incurred for sup-
understand the severity of their hedging strategies based plies and overhead do not
such impacts to financial on the financial risks a driver have the same impact on the
results. Doing this also may present. organization as expenses for
allows firms to incorporate • Solution to Issue #5: It’s marketing, advertising, or
sophisticated analyses such constantly up-to-date—As research and development.
as econometric models and the company completes a The former should be
Monte Carlo simulations into quarter of financial results, thought of as typical
the process to improve their it updates the forecast for expenses that should be
ability to predict drivers. the next four to eight quar- minimized over time, while
• Solution to Issue #3: Its ters. This process is not the latter drive the organiza-
outlook is longer-term—The about managing to an annual tion’s strategy and future. If
typical rolling forecast looks result but managing a busi- these expenses are treated
ahead four to eight quarters ness on a continuous basis. equally (as most companies
into the future, on a continu- Also, it guarantees manage- do in the budget process),
ous basis. This eliminates ment is making decisions then a dollar of marketing is
the narrow focus of the with a forecast informed by being treated the same as a
annual budget to a calendar the latest information. dollar spent on accounts
or fiscal year. Another benefit is that it payable. Simply put, this is

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28 The Journal of Corporate Accounting & Finance / November/December 2008

wrong; the way around this part of a knee-jerk restruc- growth scenario, and, as a
is to use the rolling forecast turing effort. result, they are incentivized
process to manage expenses • Solution to Issue #8: The to put forward the best
strategically. rolling forecast encourages investment opportunities to
The first step is to sepa- merit-based resource capture investment dollars.
rate all expenses into two allocation—From the cost- Management can use the
categories: strategic (drive optimization efforts just dis- rolling forecast to determine
growth and innovation—e.g., cussed, an organization now the pockets of strength in the
marketing, sales, innovation, has visibility into its strategic organization and allocate
customer service, R&D, etc.) expense base, which is the more investment dollars to
and nonstrategic (all other driver of organic growth and units that have put forward
costs). The two categories innovation. The key to suc- the best opportunities and
should then be captured and cessful management of these delivered historically. Also,
forecasted as part of the strategic expenses is to iden- because of the driver-based
rolling forecast process. On tify areas of the company that nature of a rolling forecast,
a continuing basis, as the have the best opportunities decisions to reallocate funds
company prepares the rolling and match investment levels can be made more quickly if
forecast, it will also perform with the opportunities. This a decline is seen in one por-
a cost-optimization exercise. becomes almost impossible tion of the organization. The
The optimization process in a budgeting exercise result will be improved
takes input from the rolling because profits are based on returns on strategic expenses
forecast and tracks and mon- predetermined targets. Again, and will allow greater flexi-
itors strategic and nonstrate- since rolling forecasts are not bility to react to changes in
gic expenses separately. This linked to corporate targets, the business, whether internal
information will provide this leads to a forecast where or exogenous. Exhibit 1 com-
senior management with the all units strive (almost com- pares the traditional budget
visibility into the expense pete) to achieve the best with the rolling forecast.
structure and also allow
them to provide the business
units with strategic guide-
lines on expense manage- Exhibit 1
ment. These guidelines
Budgeting vs. Rolling Forecast
should promote the goal of
maximizing strategic
expenses as a percentage of
revenue and total operating
expenses while minimizing
nonstrategic ones as a per-
centage of revenue and total
operating expenses. Obvi-
ously, both need to be kept
in accordance with overall
firm profit-margin objec-
tives. The process is power-
ful because it is done on a
continuous basis and is
linked to the rolling forecast.
Doing this keeps expense
management (cost optimiza-
tion) current, adaptable, and
top of mind, as opposed to
something that the organiza-
tion does every few years as

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The Journal of Corporate Accounting & Finance / November/December 2008 29

EMPOWERING THE BUDGET as an option for themselves, they opportunities as well as inform-
MAKERS should be mindful that they can ing major resource allocation
further enhance the value of the and expense decisions. Through
The budget doesn’t need to rolling forecast by using the data the adoption of this type of
be the “bane of Corporate contained within it for strategic holistic rolling forecasting, the
America” as Welch has articu- cost-optimization and resource- traditional budget will stand
lated. The rolling forecast allocation decisioning. transformed into a legitimate and
process offers multiple advan- Doing all this is possible powerful management tool. This
tages to senior management and with the same amount or less might result in fewer sleep-
general managers as they control effort as your traditional budget- deprived nights and might even
the organization because of use- ing exercise, but the dividends to make Welch reconsider.
fulness of the information it the organization are many, as are
offers—information that results the benefits to the people who NOTE
from an increased focus on mate- are working on the budgets.
rial items, always looking for- They’re no longer mired in an 1. See Hope, J. (2006, March 13). Use a
ward and staying current. While rolling forecast to spot trends.
exercise of dubious value and Retrieved August 28, 2008, from
many companies have begun to are now working on helping http://hbswk.hbs.edu/archive/5250.
adopt or study rolling forecasting managers understand risks and html

Dominic Paniccia is the former vice president of planning transformation at American Express, where he
led the company’s global driver–based rolling forecast process. The process is widely recognized as best-
in-class and has been referenced in case studies by the CFO Executive Board and Beyond Budgeting
Roundtable, as well as in the Harvard Business Review. He also served in the CFO’s strategic planning
group and led significant analytical projects evaluating mergers and acquisitions and worked extensively
on benchmarking competition in the credit card industry. He is currently with the consulting and advisory
firm Brilliont (www.brilliont.com), which specializes in cost optimization, organic growth, and innovation.
His blog, Dom & Dommer, can be found at http://brilliont.com/blogs/domanddommer/, and he can be
reached at dpaniccia@brilliont.com.

© 2008 Wiley Periodicals, Inc. DOI 10.1002/jcaf