Performance Management without Traditional Budgeting

How budgets steal our perspective 

A firsthand report by Olivier Fernandez 

October 2016 – the days are getting shorter, however, the work days of a controller are getting longer and longer: It is planning and budgeting time. The same in our corporation. Currently, the controllers develop a detailed five-year plan and an even more detailed budget.   

Way too many details in our planning

Until 2021, the sales at the lowest product hierarchy level are planned per client. For each product it is exactly determined in which plant it is to be produced in the coming years. The management then discusses the plan and the budget in multi-day meetings – both by means of hundreds of Power Point slides.    

Here, the future investments are particularly tricky. They constantly exceed the expectations and possibilities by far. Hence, following the meeting, the controllers have to check endless project lists thoroughly and cut projects in order to “save” investments.  

Our detailed plans are quickly outdated

Each year we make the same experience: In early summer, at the latest, the majority of the detailed assumptions and figures are already outdated. After experiencing this at first hand for a few years, I came to the following conclusion: Detailed plans and budgets make no sense anymore in today’s dynamic business environment. We make huge efforts in order to develop a fixed plan. This “one plan” is based on extensive hypotheses about the future and will never be implemented that way (as we represent it on the Power Point slides), because at the time of the implementation, everything is different.  

Detailed budgets steal our perspective

The huge effort, which we make for planning and budgeting, is a relatively small problem. I am much more worried about the fact that this huge amount of numbers steals our perspective and often directs the attention in the wrong direction. That is why in each monthly report we explain the budget deviations for a very detailed, but also very outdated budget. Most of the deviations are already known to everybody. These reports don‘t provide new findings or management-related information. An ongoing, realistic preview to the time period which is relevant for the business steering and the decision finding today, would be much more important. Only that way, the management is able to react to the constantly changing conditions. The comparison to the previous year is a suitable and adequate addition to the forecast. It provides information to whether one has improved or gotten worse in the course of time.    

Even our forecast is bothered by the budget

Three times a year, we develop a profit forecast. This should actually be a realistic preview. However, this forecast is often not very realistic, but distorted by the all-dominating (and also bonus-relevant) budget target. The same this year: In case of doubt, the budget target is confirmed in the first forecast. But budgets and forecasts have very different functions. The budget is a financial representation of planned actions designed to reach our targets. It describes where we would like to be. A forecast is a description of where we think we are heading, based on current assumptions.

In the second forecast, in the middle of the year, there are already serious doubts concerning the accessibility of the budget target, yet, the budget target is still largely confirmed. Behind this behaviour are the following considerations: By confirming the budget target, the people in charge want to show their ambition to the management. At the same time they fear that the pressure on the sales organization decreases, if the “official” forecast does not (at least) correspond to the budget target.     

Then the nasty surprise comes with the third forecast in fall: Less sales, less results and a poor cash flow due to an increased net working capital. Heated discussions in the management arise. The investors were just promised a lot more and now the time runs out. The organization has to take quick measures for a short-term improvement of the net working capital. However, in the remaining two and a half months, the possibilities for these measures are limited. It would have been a lot better, if they had this information earlier.     

If I now ask the controllers, to develop measures for a short-term securing of the results, I get the following answer: “But we don’t have any time to discuss the net working capital now, we have to focus on the five-year plan!”