Read Part 1 first:
The Most Crucial Budgeting/Forecasting Pitfalls to Avoid (Part 1)
- Pitfall #1: Budgets functioning as a status symbol
- Pitfall #2: Budget figures containing exaggerated buffers
- Pitfall #3: Day-to-day business as a black-box (from management accountant’s view)
The following part continues with this issue and addresses three other main budget pitfalls to avoid.
Pitfall #4: A lack of commitment from managers with budget responsibility
This pitfall can result from two factors. First, it is quite possible that both budget managers and cost managers lack seriousness and neglect due diligence during the yearly planning stages—budgeting is seen as some kind of bureaucratic obstacle, wasting time and resources for the daily business.
This annoyance gets even worse if the prepared budget has little significance within the company during the period. Budgetary or cost controls barely take place; budget overruns are commonly tolerated because of a lack of accountability. Eventually no one is held accountable for negative variances between budgeted and actual expenditures or revenues, and the corporate culture is not able or willing to initiate course-correcting measures quickly to soften costs or revenues that get out of control. Someone might ask, “Well, why then take on this mammoth task of budgeting, or rather forecasting in general, if the outcome is so little?”
To take the management accountant’s view, we can state that especially after budget preparation, the idea of budgets needs to stay alive throughout the fiscal year within the organization—beginning at the upper management level and proceeding to lower areas of responsibility. Sales and cost managers get confronted with “their” poorly performing key performance indicators (KPIs), and counteractive measures are called in to close the existing target gaps. Budgetary controls—that is, analyzing whether and why there were negative variances of actuals compared with targeted figures—need to be performed on a regular basis.
Since the budget managers are expected to follow their budgets, they need support in terms of monthly or year-to-date results for their cost center(s) on a regular basis—otherwise, it would hamper their ability to act swiftly, make reasoned decisions, and correct the course if necessary. Therefore, management accountants should communicate figures and provide regular reporting packages, typically on a monthly basis, showing budget variances and actual developments of the specific business units.
Optimally, these reporting schemes should include additional narrative explanations of the main reasons for any variance, and not only examine financial but also non-financial indicators with an influence on the overall performance (e.g. customer and employee satisfaction, quality, innovation, new product development, and so on).
As a second reason for that pitfall, commitment may be missing during the stages of budget preparation as well as later on in the budget cycle if budget managers are not sufficiently integrated into budgeting processes: (unrealistic) budget targets are communicated (unclearly) following a top-down approach, based on strict demands from the executive board. This means cost managers, who are finally charged with the execution of the plan, are not allowed to participate satisfactorily and to announce their points of view in budget preparation talks.
Only the budget managers who feel that they have contributed to and given extensive inputs during the budgeting stages as well as have been measured and compensated against realistic targets will be motivated by incentive systems and can identify with their budget(s).
To sum it up, management accountants should try to lead budget procedures in the right direction, and therefore ask the following questions:
- Which indicators and cost drivers do we use to measure performance and manage departments/divisions?
- Which targets are the most realistic, influenceable and motivating ones for a specific cost center—also from its budget manager’s perspective?
Pitfall #5: Missing link between the corporate’s goals and measures
Setting targets relating to sales volumes, turnover or costs is the proper first step. But what about planned and determined measures to reach those goals? That question is often neglected while holding the individual budget discussion: for example, one goal is the raising of sales revenues in region A by about 15% during the next 12 months while simultaneously reducing overall costs by 10%. However, adequate measures and potentials to reach these ambitious targets are merely discussed in a quick rush and therefore not defined appropriately.
The combination of the interdependencies between sales or cost targets on the one hand and constructive actions on the other—not to forget a detailed specification and documentation for controlling functions afterwards—is a critical success factor. Budgetary controls during the period should not solely focus on a question like “Have we reached/will we reach our targets?” but instead discuss an extended version like “Have we been able to implement planned measures under reasonable terms to foster the achievement of objectives eventually?”
Pitfall #6: Only living in the here and now—neither willing to learn from past experiences nor to look ahead
Budgetary planning and its processes are repeated every year. Thus, at least theoretically, every 12 months, the participants in budgeting get the chance to critically reflect on the previous year’s budgeting procedure and to seek room for improvement. However, reality sometimes looks different and previous practice barely gets questioned because of limited temporal and personal resources or an ill-founded hold on old habits (“We have always done it that way!”).
So, what are the reasons for variances between budgeted and actual expenditures/revenues? Do those solely result from too conservative or aggressive budget mentalities or are there maybe deficits resulting from the planning system and its methodology in general? What could be improved regarding the targets and the operated measures to reach those goals?
Also, companies that cannot deal with their past budgeting processes often face similar problems in terms of a solid vision—meaning that the budget managers are not willing to deal decidedly with prospective developments in their business. All too often, assumptions and targets are drawn hastily and imprecisely during the budgeting stages—e.g. “Next year we will increase sales by 6% for sure while holding our costs steady!” However, is that target congruent to the general economic expectations in the market? Which changes may increase/decrease profits and which are the further side effects? Besides, is it even economically worthwile to adopt past measures?
The insufficient procedures of taking last year’s results and simply adding an inflation factor—without taking into account structural changes in the business or its environment (competitive position) which call for much more significant budgetary adaptions and changes in fund allocation from period to period—are also known as “incremental budgeting”.
While working as a management accountant and attending budget discussions, you should always seek to break through such behavior of budget managers that focuses too much on the present—because simple extrapolation of past and present data could indeed be correct, but may also draw an absolutely incorrect picture. Instead, a deep engagement with the internal and external influencing factors on economic efficiency as well as future chances and risks should normally allow a better derivation of assumptions for your budget planning.
Are you in the midst of your budget planning actually? Any tips to share with our readers?
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Must-read blog posts about management accounting and financial control—classical topics, as well as modern subjects, latest trends, and current challenges in the management accounting discipline. Aimed to inform, inspire, and entertain management accountants and anyone with a deeper interest in management accounting.