“Broken. Inefficient. Dysfunctional.”
For what seems like forever, these are the words that have been used to describe traditional corporate budgeting. Harvard Business Review (HBR) didn’t mince words when they declared, “Corporate budgeting is a joke, and everyone knows it.”
Theories abound for how to fix the process, but there’s one in particular that’s capturing the C-suite’s attention: Beyond Budgeting. It’s a radical rethinking of the entire management model that gets at the root causes of dysfunction and bias, championing a shift away from the rigid, annual planning cycle towards a more adaptive approach.
It also happens to be particularly well-suited to capital planning. If you have any stake in capital allocation/Capex management, it’s worth paying attention to.
The cascade of problems that come with traditional budgeting
Traditional corporate budgeting is notorious for being ineffective and time-consuming. But what’s worse is that the process itself often creates more problems that it solves, including:
- Pressure to hit often unrealistic targets can incentivize P&L owners to engage in questionable behavior like inflating their top line or deferring expenses.
- An incessant focus on short-term budget goals can lead to decisions that hinder long-term value creation.
- The rigidity of the process makes it difficult to adapt to inevitable market changes, leaving companies flat-footed in the face of disruption.
If you’ve been in finance long enough, you’ve likely seen the havoc these warped incentives can wreak. HBR highlighted a particularly striking example: managers at a global heavy-equipment manufacturer, feeling the heat to hit their quarterly numbers, resorted to shipping unfinished products across borders. The result? Exorbitant, unnecessary costs that eroded the company’s bottom line.
We’ve heard of countless similar cases in conversations with customers. As BCG explains, there’s a fundamental tension at work: “Traditional budgeting is like trying to square a circle, because the process tries to meet…ultimately incompatible objectives.”
Fortunately, there’s an antidote to this budgeting madness.
Beyond Budgeting: What it is and how it works
1. Shifting from fixed annual budgets to rolling forecasts
Budgeting season tends to be the busiest time of the year for finance teams. Over the course of several months, they meet with department heads and executives, and use what they learn to come up with a high-level corporate budget for the coming year.
Yet, after all effort, by the time the budget is set in stone, it’s often largely obsolete. Assumptions have changed, the marketplace looks different, and the strategic direction has shifted. This misalignment only grows as the year goes on.
This structure “well suited for the previous stable business environment,” but today, as Felin and Powell point out, “the old tools of organizational design…are not well-suited to success in volatile markets.”
A study from Uppsala University looked at an e-commerce company’s experience with traditional budgeting, and found that “The detailed budget was…exceptionally time-consuming and estimated numbers were “locked in” too early,” leading an executive to admit that “when the budget was ready, we knew it was 100% wrong.”
A more flexible approach that allows for constant adjustments to the budget can prevent these issues. That’s what rolling forecasts promise—a more adaptable framework that keeps your company’s strategy and resource allocation in lockstep with inevitable business changes. Rather than projecting what the next 12 months will look like and starting over each year, a rolling forecast simply adds another month to the forecast as soon as one ends.
These benefits extend to capital planning as well. In a traditional setup, teams have to wait until budgeting season to request project funding. By the time a project is greenlit, the opportunity may have come and gone. With rolling forecasts, you can seize opportunities as they arise by submitting and evaluating capital requests throughout the year. Without having to fit into the confines of the corporate calendar, projects are funded exclusively based on their risk-adjusted ROI and strategic impact.
2. Streamlined decision-making
Department heads know their businesses better than anyone else, and usually have the best idea as to which projects will support the organization’s strategic goals.
But red tape, bureaucratic gridlock, and lengthy approval processes, which are part and parcel of traditional budgeting, slow everything down.
This is where the ‘mindset shift’ part of Beyond Budgeting comes into play. BCG puts it this way: “Beyond Budgeting involves not just a change in process but also in how management thinks about the future and about managing people. Managers shift from politburo-style central planning and command-and-control decision making to directional guidance, delegation, and trust.”
Streamlined decision-making as a result of Beyond Budgeting can help leaders:
- Capitalize on emerging opportunities: Pounce on opportunities as soon as they open up by shortening the time between project approval and shovels in the ground.
- Allow capital to flow to the most promising projects: Maximize your return on invested capital (ROIC) by doubling down on winners and immediately funneling capital away from underperforming areas, rather than having to wait a year to do so.
3. Focusing on relative performance targets and KPIs
The Beyond Budgeting framework does away with arbitrary budget targets that incent managers to “game” the system. In its place are directional targets set by business units themselves that keep everyone’s incentives aligned by injecting a healthy dose of competition into the organization.
BCG notes that “Top-level metrics, such as revenue, EBIT, or ROCE, are all effective targets, especially when compared with peers and complemented with relevant nonfinancial metrics. Ratios, such as unit costs, are typically more meaningful than absolute numbers.”
This focus on relative performance ensures that your teams are constantly seeking to exceed expectations, rather than sit back once they’ve hit a number that may or may not be strategically relevant.
4. Aligning resource allocation with strategic priorities
Rather than allowing capital to flow freely to the most promising opportunities, the traditional budgeting process traps it in a predetermined plan. The Uppsala University study found that this often leads to a “use it or lose it” mentality, with teams scrambling to spend leftover budget at year-end, regardless of whether it aligns with strategic goals.
Beyond Budgeting advocates for an on-demand approach to resource allocation. “Instead of defining rigid, top-down spending envelopes a year in advance, companies that use a Beyond Budgeting approach address resource allocation by combining broad target setting with better reporting,” cites the BCG study. Some companies do this via zero-based budgeting, in which they start each period from scratch, rather than where they landed in the prior year.
5. Cultivating a culture of trust, transparency, and collaboration
HBR bluntly notes that traditional budgeting “turns business decisions into elaborate exercises in gaming. It sets colleague against colleague, creating distrust and ill will.” Finance and department heads both lose sight of the bigger picture as they pursue their individual targets.
In contrast, Beyond Budgeting ensures that everyone’s rowing in the same direction by making information open. When the fear of losing next year’s budget is removed, teams can focus on making decisions that benefit the entire organization, not just their own department.
In terms of capital planning, this means fostering an environment where teams feel comfortable sharing ideas, challenging assumptions, and collaborating to identify the best investment opportunities regardless of which department they reside in.
Modern capital planning requires going beyond budgeting
The evidence is clear: the traditional budgeting process may be holding your organization back. This can be particularly true as it relates to your Capex growth projects which typically incur higher investment thresholds, require more financial and strategic discovery and discipline, and will include a cross-functional team. Which is why capital management is a prime candidate for introducing Beyond Budgeting approaches into your organization.
Moreover, change management in capital planning is typically less disruptive than areas like labor or Opex, as capital projects often have longer timelines and more flexibility for adjustments. You can start with a pilot project or department, and gradually expand your Beyond Budgeting implementation as your organization gains confidence in it and has results that carry weight.
As with any transformative approach, having senior management buy-in is essential, as is utilizing purpose-built software tools to remove the “friction” that often accompanies change—such as accurate “real-time” data … the ability to perform analyses in uniform and insightful ways … and efficient processes for “democratizing” those insights. That’s what Finario brings to the table.
Want to learn more? Watch the webinar replay to learn how Capex stakeholders can introduce this concept in their organizations.