A budget is a financial plan that estimates income and expenses over a specific period, typically for a business, organization, or individual. It often involves setting financial goals, estimating future income sources, forecasting expenses, and establishing limits or targets for each expenditure category.
Budget was defined as a "quantitative expression of a plan for a defined period of time." However, this definition falls short of capturing the importance and evolution of budgeting in the corporate world. In this post, we will delve into the origins of budgets, their current status, and their uncertain future.
1760-1920 – Budget Origin
The term "budget" finds its roots in the Latin word "bulga," which refers to a leather bag used for carrying supplies of food. Over time, the meaning expanded to include both the container and its contents.
The concept of budgeting started in England around 1760 when the Chancellor of the Exchequer presented the national budget to Parliament each fiscal year. Its purpose was to limit the king's power to impose heavy taxes and control public spending. In 1837, the Reform Act made the budgeting process more effective.
1920-1930 – The Inception of Corporate Budgeting
Across the Atlantic, the United States also embraced the idea of budgeting. President William Howard Taft initiated government budgeting in 1911, laying the foundation for the business world.
Business budgeting gained prominence through the efforts of individuals like Donaldson Brown and J.O. McKinsey. Brown introduced budgeting at DuPont and General Motors, pioneering flexible budgeting systems by 1923. McKinsey's 1922 book, "Budgetary Control," established him as a central figure in business budgeting.
The Titans of Planning
James O. McKinsey, Donaldson Brown, Alfred Sloan, and Marvin Bower played pivotal roles in shaping modern budgeting.
Donaldson Brown developed the DuPont formula, breaking down investments and working capital into categories. His work was published in 1950 and emphasized the importance of forecasting and planning.
In 1922, J.O. McKinsey published "Budgetary Control," which laid the foundation for modern budgeting practices. McKinsey highlighted the need to focus on the future rather than just historical data.
Marvin Bower, a student of McKinsey, led McKinsey & Company and advised the U.S. government on budgeting. He advocated for responsible spending and emphasized the challenges of forecasting accurately.
1987 – Excel's Impact
In the 1970s and early 1980s, financial experts would spend a long time doing complicated math either by hand or using programs like Lotus 1-2-3, starting in 1983. The launch of Microsoft Excel in 1987 revolutionized budgeting by enabling complex modeling and calculations. Excel is known for basic math like addition, subtraction, multiplication, and division, but it can also do more advanced things with functions like IF, VLOOKUP, INDEX-MATCH-MATCH, and pivot tables. Excel became an indispensable tool for financial analysts.
1990-2009 – Challenges and Critiques
Budgeting in Excel, while initially handy, faced mounting criticism due to its inability to keep pace with the increasingly intricate business landscape. Critics argued that traditional budgets struggled to stay relevant and often encouraged manipulation of goals. In a notable article by Jack Sweeney in the June edition of Business Finance, he pronounced the 'death of the budget,' contending that annual budgets, in use since 1922, became outdated shortly after creation. Some companies even abandoned budgets entirely due to concerns about target manipulation.
Despite these critiques, a 2021 survey of 500 CFOs and FP&As revealed that none had entirely discarded budgeting. In fact, 66% of finance leaders insisted that having a budget document was essential for both short-term and long-term business planning. Criticism of budgets persisted, primarily due to the inefficiencies it imposed on finance professionals, especially as the budgeting process shifted to newly formed FP&A analyst teams. The process was time-consuming, with 42% of businesses taking up to three months and another 42% taking four to six months to complete the annual budget. These manual tasks, often reliant on Excel, included error identification and correction (64%), manual report updates (63%), data collection and compilation (60%), and tracking multiple report versions (54%). Nevertheless, despite these criticisms, budgeting remained a valuable tool for many finance leaders in guiding their business planning efforts.
2005-Present – Exploring Beyond Traditional Budgeting
Beyond Budgeting wants to reduce the old way of budgeting and find better ways to manage finances in businesses. It suggests that companies should move past traditional budgeting because it has some flaws. It advocated for more frequent budgeting through techniques like rolling forecasts and market-related targets.
In 2008, Robert Kaplan from Harvard Business School wrote a foreword for Bjarte Bogsnes' book about Beyond Budgeting. Here, he questioned the utility of fixed annual budgets in today's dynamic environment which is expensive to prepare. So, businesses are looking for new ways to manage their finances.
2016 and Beyond – Businesses Adapt
Ivo de Brouwer, the finance director in charge of Controlling Methodologies at Danone, a French food company, noticed a big shift in how companies handled budgets. In the late 1990s, the old way of budgeting worked because companies could reasonably predict and sometimes influence what would happen in the future. They made an annual budget and adjusted it as needed based on real results.
However, by 2016, Danone and many other companies faced a different reality marked by lots of changes, uncertainty, and complexity, often called "Vuca." The old budget process didn't work well anymore. To adapt, De Brouwer and his team started using "rolling forecasts." This meant they always looked about a year and a half ahead to predict what might happen and planned for different scenarios, including the best and worst outcomes. The pandemic made the challenge to traditional budgeting even bigger.
Budgeting Shifts During Pandemic
COVID-19 has accelerated the shift away from traditional annual budgets towards rolling forecasts and real-time data. Manish Gundecha, FP&A Director at HP, emphasizes the importance of dynamic budgets, noting that static budgets quickly become obsolete when unexpected events like the pandemic occur. He highlights an example where HP had to quickly adapt to supply laptops to Japanese high schoolers during the pandemic, a scenario that wasn't part of their historical trends. This agility allowed HP and other tech companies to compete for a significant opportunity.
The evolution of budgeting, referred to as Rolling Forecast 2.0 by Danone, involves a more extensive integration of internal and external data. It empowers individual countries to set targets and places a greater emphasis on scenarios and non-financial data. This approach recognizes the significance of non-financial events, such as social media-driven disruptions like an activist investor's impact on Danone's budget in Morocco. COVID-19 has pushed organizations to rethink their financial strategies and incorporate flexibility to adapt to unforeseen circumstances, as seen with LEGO Group reinvesting travel savings and Amwell's enhanced services in response to the pandemic's challenges.
A budget serves as a critical financial plan for businesses, organizations, and individuals, estimating income and expenses over a defined period. It helps allocate resources effectively, monitor financial progress, and make informed spending and saving decisions.
Despite the challenges of modern budgeting, it remains indispensable, with many finance leaders emphasizing its importance in both short-term and long-term business planning.
Recent years have seen a shift towards more dynamic approaches like rolling forecasts, real-time data integration, and AI powered budgeting tools that help with automation. By creating and following a budget, individuals and organizations can manage their finances, prioritize expenditures, and work towards achieving their financial objectives.