In the volatile and challenging times brought about by COVID-19, changing our thinking on traditional budget forecasting can make planning ahead easier. Budget forecasting in unprecedented times is particularly vital when gauging long-term impact and engaging staff in the budgeting process.
Anyone in business with the job of looking ahead knows it’s a mistake to try to look too far ahead, particularly in uncertain times, but there are methods that can provide a road map to the future and help finance professionals avoid dead ends and potholes.
The place to start is, to rethink the budgeting process.
Most organisations struggle with budgeting because the future is always hard to predict, and managers generally don’t want to make firm on-the-record forecasts, particularly in times of frequent change. There are two intrinsic weaknesses, firstly, there is the inherent difficulty in predicting how the real world will impact the organisation in the future. Secondly, there is the issue of getting managers and employees to engage with this process in an authentic way. Usually, it is a bit of both!
The most common form of budgeting in Australia is the annual budget, usually structured in a traditional way and broken down by divisions, business units and even teams.
Monthly and quarterly rolling budgets are often used alongside annual budgets in larger organisations.
By and large, a budget is the expected financial quantification of a company’s goals, ideally based on a considered reflection of its circumstances.
It is then used as a tool to hold managers accountable for a level of performance. In being used to evaluate performance, however, it sets off a chain of incentives that lowers its utility for planning and resource allocation.
The main weakness is the unyielding focus managers and staff have on over-specifying the use of a budget as a performance evaluation device, while missing its value as a planning and management device. These are related, but by over-emphasising the evaluation, we ruin planning. Emphasise planning, and you reduce the negativity associated with evaluation.
Telling employees their performance assessment will be judged on adherence to a set of numbers can induce pressure. If targets are too difficult to achieve, they naturally discourage creativity and innovation. However, the same budget that is perceived as a constraint can also enable people. If a looser, more generous research and development (R&D) budget is given, for example, it encourages staff creativity.
Getting ahead of the curve
It is human nature to stay with the safe and the known if we are rewarded for doing so. What we need is to take the pressure off budgets as the sole determinant of performance evaluation.
We need to be able to look at the larger picture from a forecasting perspective. When mapping out the way forward from the COVID-19 crisis, for example, this means staying up-to-date with information on how the economy is reacting to the changes that unfold.
It is also important to be aware of emerging technologies and social issues, so that longer-term objectives are met, rather than just the annual profit target. Resources can then be allocated through the budget process to areas of the organisation that are most likely to face challenges, or where there are opportunities to mitigate the impact of extreme events.
This can be disruptive compared to the steady-as-she-goes mentality often associated with traditional budgeting and requires bold leadership.
Forecasting methods are likely to vary across industry sectors, and the team responsible for looking ahead needs to choose the right metrics and most appropriate time-frame.
Financial institutions, for example, need to look at likely future interest rates and the economic framework with a long horizon. In the retail sector, forecasts are better made on a weekly or monthly basis. Yet the fundamental principles of taking a broad view, considering a range of data and acknowledging uncertainty are universal. There are software tools that can help with forecasting, but they are no substitute for a strategic mindset.
No software explains uncertainty and what we need is a willingness to embrace uncertainty. When you determine budgets at the start of a period, you know they’re likely to be wrong. If you can accept this and work with it, you’re ready to start thinking about smarter ways of benefitting from a budget.
What forecasting software can do for you
Forecasting apps are straightforward and easy to use, drawing out budget numbers or recent actual figures from accounting software. These tools enable you to prepare for the year ahead by plugging in different growth scenarios and running the numbers.
Another useful function – particularly for small businesses – is the ability to feed the software information on how quickly invoices are paid in order to create a picture of cash flow.
Financial forecasting is crucial to ensuring the ongoing viability of your business. DGL Accountants specialise in monitoring processes to help you manage your money, so get in touch to implement budget forecasting into your business.
Budget forecasting tips brought to you by our friends at InTheBlack and the Team at DGL Accountants.