Your budgeting process is broken
Despite its criticality to business success, the budgeting process at many companies is currently broken. There are four major reasons for the present state of budgeting at India Inc.:
Firstly, budgeting at most companies is anchored in the past. What this means is that the budget for the coming year is usually an incremental revision of last year’s numbers. Such anchoring is a common cognitive bias that leads us to become over-reliant on one piece of information - usually the first piece - when making decisions. As the process typically starts with a review of the previous year’s results, subsequent discussions tend to circle around these numbers.
The second flaw in the budgeting process is the tendency for it to turn into a gaming exercise between senior management and department heads. As a result, budgeting often becomes an exercise in developing targets that are acceptable rather than achievable.
For example, heads of department may accept unattainable targets to satisfy their senior management’s top line goals, in full expectation that they will not be achieved. Conversely, senior management may accept low-ball targets from their teams which under-estimate the real business potential and are easily surpassed.
At one company we worked with one division had achieved 100% of its previous year’s target while another division was languishing at only 30%. However, after closer scrutiny, we found that the divergent performance was largely related to the very different ways in which their targets were set.
The third gap in budgeting is the disconnect between the process and the current market reality. In today’s fast-moving environment, rapidly changing customer behaviour and new competitive threats are disrupting many of the assumptions that have been built into the budgeting process over the years. As a consequence, budgets are increasingly out of step with the latest market developments.
The final break in today’s budgeting process is its lack of agility. Budgets are set in stone at the beginning of the year and targets are cascaded down through the organisation accordingly. Therefore changing course in response to new circumstances is like turning around an oil tanker. Furthermore, as employee rewards are linked to these annual targets, there is little incentive for individuals to rock the boat by taking initiative and re-directing their efforts mid-course.
Many Indian companies experienced the most dramatic example of the need for budget revisions during the demonetisation shock of 2016 which saw sales slump as much as 30-50% during the affected months.
Given these four dysfunctions in the current process, there is a clear need for companies to take a fresh look before repeating the same mistakes in this year’s budgeting exercise.