Risks in Budgeting and Forecasting Process

When I go shopping more often than not I blow my budget. You see, in the shopping mall my requirements far exceed the forecast. My three finance qualifications come to naught in this simple expenditure planning. So I understand why budgets of organizations go wrong. But the risks associated with an organization’s inaccurate budgeting and forecasting process are far higher.

For instance, the CAG report on Air India states that airplanes were purchased based on an estimated huge market growth and share. The government airlines is now nearly bankrupt. More recent is the case of Kingfisher Airlines. The company is facing a huge liquidity crunch and may go bust if banks do not bail it out. Though I haven’t analyzed the financial statements, the question does come up – didn’t they see this coming? What kind of cash flow forecasting was the finance team doing? The airlines grew quite fast, where there any checks kept on expenditure and how was it linked back to revenues?

These are basic questions, and show the impact on the organization when proper techniques are not used for budgeting and forecasting. In the next quarter, Indian organizations will commence their budgeting process for the financial year 2011-2012. I thought it is a good time to study the best practices of budgeting and forecasting, and share with you my understanding of the risks associated with it. I delved into the SAP CFO forum research papers and here are some interesting points.

1. Business Drivers for Budgeting and Forecasting

According to Aberdeen and SAP report the top three drivers for budgeting and forecasting in 2011 were to help organizations deal with market volatility, aligning strategy and doing cost control. As these three have been major drivers for the past three years, one can safely assume considering the global economy that in 2012 also, these three will prevail.

 Moreover, Indian economy year-end scenario is turning bleak. As per recent reports GDP is expected to show just around 7.25-7.75% growth in 2011, instead of the initial 9% growth forecast. Sensex has fallen one fifth in the year and presently India is among the worst performing stock markets in the world. Organizations have cut down on capital expenditure to maintain profitability. Hence, in the coming financial year, Indian organizations will face all the five pressures mentioned in the graph above. Therefore, it has become more critical to do accurate budgeting and forecasting.

2.   Risk Adjusted Forecasting

In another SAP white paper titled “Increasing Competitiveness through Closed Loop Performance Management” I came across an interesting point. It emphasized on implementing integrated financial performance management processes that “comprise strategy planning, budgeting and operational planning, forecasting, management reporting, profitability and cost management, and risk management.” It further added that in most organizations the “various performance management systems remain disconnected specially risk management.”

Now the question that begs an answer is – are risk managers having a look at the budgeting process to ensure all management systems are linked together? Secondly, are they reviewing the budgets, facilitating the business teams in identifying risks and adjusting the budgets accordingly?

In my view if risk managers are taking a hands off approach during the budgeting process, then they are doing the organization a major disfavor. They should proactively participate in the process, identify the problem areas and discrepancies, highlight the risks and inaccuracies, and facilitate management in preparing flexible budgets.

The benefits of this approach can be seen in the Infosys case. The company was recently in the news for asking its employees to sacrifice two Saturdays in this quarter to meet the budgets. Though I have different views on the action taken by Infosys to call employees on weekends, it does show that they are proactive in managing their forecasts. The management assessed the risk of failure of forecast and took action. Hence, there is a lesson to be learned here for all organizations. Organizations should build in internal and external events triggers for internal and external  events to adjust forecasts timely.

3. Flexible Forecasting

A new report of SAP with CFO Research Services highlights the risks of having fixed budgets based on historical data. It states that due to the changing business environment forecast numbers are “continually measured against real-world results and recalibrated to meet new threats and take hold of new opportunities as they arise. “ Further on it adds that “The time-honored tradition of beating the budget by surpassing revenue targets is no longer a reason for celebration; it’s one sign that the budgeting process took so long that the assumptions underlying it grew stale.”

The CFOs interviewed in the report state that building flexibility into planning assumptions and processes is of paramount importance. With Mobiles and Tablets, realtime information on sales, expenses etc. is available. Hence, now forecasts require regular examination of the underlying assumptions. The market dynamics ensure that one has to go back to the drawing board periodically to study the movement and re-strategize. Annual fixed budgets are becoming a thing of the past and CFOs are in favor of rolling budgets.

In light of this aspect, the points I mentioned in my earlier post that risk managers need to actively participate in strategic risk management holds true. In this scenario, risk managers must review the budgets assumptions and risks on a monthly/ quarterly basis to ensure smooth sailing. A once in a year periodic review doesn’t hold much water. They must make sure that organization’s strategy, operations plans, and budgets are continuously aligned.

Closing Thoughts

Budgets are no longer just the domain of finance department. In the present environment budgets must be developed with a combination of top down and bottoms up approach. While the strategy is developed at senior management level, the execution plans are developed down the lines. They have the real information on market dynamics, numbers and risks. The views of various departments -sales, human resources, purchases etc. need to be incorporated to form realistic assumptions and understand associated risks. Hence, risk managers have a significant role to play in this process.

Share your opinion here. Do you think Indian organizations have robust budgeting and forecasting processes?

References:

  1. Economy in Distress as Factory Output Slumps : Economic Times 13 Dec 2011
  2. Financial Planning, Budgeting & Forecasting in the New Economy : Aberdeen Group with SAP
  3. Increasing Competitiveness through Closed Loop Performance Management – SAP
  4. Accelerating the Speed of Intelligence for Fast and Flexible Forecasting – SAP with CFO Research Services

You can find the reports at http://www.sapcfo.com/

This article was published in The Business Enterprise Magazine January 2012 issue.

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One comment on “Risks in Budgeting and Forecasting Process

  1. Budgeting and forecasting are so important to making financial predictions. Though they are not always accurate, they do provide the the business with at least a rough idea of where there business is going.

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