Annual Budgeting Is a Pricey Illusion – Time to Dump It for Good
Annual Budgeting Is a Pricey Illusion – Time to Dump It for Good
You don't need a strategy. You need to see the world strategically. Welcome to the newsletter for deep thinkers.
Autumn has arrived, and companies worldwide have kicked off their annual round of that tiresome, pointless, and utterly useless game called budgeting, aka Annual Strategic Planning.
This has about as much to do with planning as rearranging office furniture has to do with a growth strategy.
I believe there is a much better and faster way to save our planet from global warming than green transition and other initiatives: we should cancel annual budgeting.
I am joking, of course.
But the amount of time and effort companies waste on the process is disproportionally large compared to its outcomes.
This article will help you save hours on useless negotiations.
What’s wrong with Annual Strategic Budgeting?
We evaluate athletes by their wins.
We evaluate businesses by their profits.
An executive is assessed by the size of their annual budget.
What may seem like mere political games to a casual observer is, for the executives, a Darwinian struggle for survival.
In an imaginary normal world where we act logically and reasonably, we would need budgeting to build better plans. In the real world, though, we need plans to justify our budgets.
Every year, millions of employees churn out tons of junk in the form of PowerPoint presentations, all with the sole purpose of negotiating a bigger budget for their departments.
Even if the CEO has a strategy, they still don’t have clear criteria to evaluate executives’ bids for annual spending.
For instance, the strategy entails that the company should ‘become a market leader by providing exceptional service for its customers.’ Now, the Head of Logistics and the CMO are demanding additional budgets for fast delivery and its promotion. How is the CEO supposed to make a decision?
Annual strategic planning, or budgeting, turns into tough negotiations in which customers are hostages. Executives use them as leverage to bargain bigger budgets.
The negotiations will end by Christmas or New Year. Both the winners and losers will go off to celebrate holidays, only to find out in January that nothing goes as planned.
What can you do instead?
Point 1
A contrarian take – annual budgeting isn’t a reason to bargain.
Your strategy must answer the following questions:
1. Who are our target customers?
2. What are their needs?
3. What values will we create for them to satisfy their needs better than our competitors?
4. What Value Waves should we create or develop to create these values?
Value Waves are key processes that you need to create or develop to deliver exceptional value to your customers and other stakeholders.
Your strategy and strategic financial model should already outline, at least in general terms, the scale of this development and the corresponding expenses.
For example, if you bet on fast delivery in your strategy, your logistics and inventory management processes will be among the ones you will focus on. And you should know beforehand how exactly you will develop them, and how much it will cost.
You should discuss it once while crafting the strategy, and you shouldn't change it every year unless you need to tweak it.
Your business exists not to inflate your executives’ egos or compensation packages.
It exists to satisfy the needs of six stakeholder groups, with customers above all.
Adjust your strategic financial model if necessary, and don't waste time on annual budgeting.
Point 2
The traditional P&L budget is broken down into expense categories. These categories are grouped by similarity.
For example, finance teams typically group together all rental costs, all transportation expenses, all employee payroll, etc. However, various employees in the office contribute differently to customer value. The same goes for transportation or rental costs.
A company operates not by spending money according to the budget but by performing processes that must create value for stakeholders.
Break down your expenses not by categories but by Value Waves, e.g., high-level processes.
How much does product manufacturing cost in your company?
What about warehousing? Delivery? Sales? Customer acquisition? Hiring and training? Accounting?
The costs for each process will include all the expenditures necessary for its execution, from wages and office rent to electricity and communication expenses.
Your strategy will indicate which processes are a priority and help you set respective objectives and KPIs. At the same time, you'll have a clear criterion for funding various processes for the next year.
Your P&L is merely the shadow of a reflection of how your processes truly operate. The processes determine your success.
Point 3
There are two types of expense categories:
– The ones that you can manage flexibly
– The ones that you can’t
Plan the expenses from the first category for the whole year and don't adjust them unless absolutely necessary.
Build two or three scenarios for the following year's revenue and gross profit. Give your executives 'ranges' for possible fluctuations in their expenses, depending on which scenario plays out.
Create an 'early warning system' to quickly understand which scenario is going to happen.
Conclusion
1. Your business exists not to inflate your executives’ egos. It exists to develop by satisfying stakeholder needs.
2. Your strategy shapes your budget, not vice versa.
3. Break down your expenses by the processes because the processes are what your company performs every single day. They determine your success.
4. Set goals and target cost standards for each strategically important process. Conduct annual budgeting in line with these standards.
If you have any questions about strategy or budgeting, do not hesitate to comment on this post or send me a DM.
I'd also like to remind you that the price of the program Fast-Track Strategy: Craft Your Strategy In a Few Simple Steps will increase by 30% on Thursday, October 10. This is your last chance to purchase it at the old price. Paid subscribers get a discount. Read more here.
Check out my book Red and Yellow Strategies: Flip Your Strategic Thinking and Overcome Short-termism.
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Very perceptive points Svyatoslav! There's a negotiating dance to the annual budgeting process, and (as you state) the size of Departmental budgets is often more to do with the ego of that Director than investing in the strategy. A process-led view of resources can be a powerful (and strategic) perspective, much underused!
Thanks. Two things.
There’s more to strategy than financials. Budget allows you to execute strategy, but it’s often the only thing discussed in a strategy meeting.
Watch out for people that want bigger budgets, but try to shift their costs to another department.