Budgeting as a tool can be very useful but the traditional budget is a product of a distant past. During most of the 20thcentury, manufacturing dominated the industrial landscape. These businesses were hierarchical and capital intensive. It was the job of managers to oversee the deployment and allocation of capital. To do so, they needed strict controls over capital allocations and information to understand how closely they were tracking to their financial objectives during the year. Couple this with a business environment that was minimally impacted by globalization and it’s easy to see how a detailed, static budget was sufficient to provide value to management.

Unfortunately, while the world changed the annual planning cycle remained relatively unchanged, the budgeting process has remained relatively static. Whereas in the past manufacturing facilities and production volumes helped determine corporate value, companies today are far more likely to create value through product innovation, mass customization and agile supply chains. Given the new realities, traditional budgeting suffers from the following issues:

The traditional budget takes too long to prepare. It isn’t uncommon for a budget to require 4 – 5 months and consume a substantial portion of executives’ time.
The budget is too manual. Many companies prepare and consolidate their annual budget in Excel. This increases the time necessary to develop the budget and exposes the budgeting process to human error as spreadsheets are manually combined to reflect organizational roll-ups.
The level of detail is too great. At some companies the budget is at the same level of detail in the Chart of Accounts. This creates far more complexity than is necessary. Instead of facilitating the budget process, it actually becomes a hindrance to the creation and monitoring process.
The number of iterations is too high. A typical budget can require 5 - 6 iterations before the numbers are accepted by senior management. Leading companies focus on minimizing the number of iterations to reduce the time and effort spent on budgeting.
Budgets are internally focused. Most of the numbers in the budget are based on previous years’ data. All too rarely is a budget based on existing and anticipated economic factors that drive volume and cost. Few companies evaluate their proposed revenue and cost structure based on similar companies in the industry. Finally, the budget measures internal metrics such as revenue growth, but fails to take into account other levers of value such as customer satisfaction.
Budgets lock in costs through the year. While the budget is thought of as a tool to control costs, all too often costs are locked into the budget for the year. Even if economic conditions vary widely from the assumptions upon which the budget was built, the company’s cost structure resists downward pressure as those costs were budgeted for the year.
Politics permeates most budgets. The annual budgeting process has become a high-stakes game of bluffing. Many managers “pad” their budgets with extra costs so that they end up with something they envisioned after their budget requests have gone through multiple iterations.
The budget is quickly obsolete. Given that the budgeting process can start four or more months before the end of the fiscal year, and coupled with a dynamic business environment, it’s no surprise that many budgets are obsolete after the first month of the fiscal year.

In the third and final post in this series, I'll discuss eight leading practices in the budgeting process.