As we approach the end of the financial year for many businesses, most would normally be in the midst of developing budgets for the coming year. These would reflect the strategic plans developed and reasonable assumptions about economic conditions and market changes.
But these are not normal times.
The world is in the grip of the COVID-19 pandemic. Normal business operations are disrupted – some for better, most for worse. Economies are feeling the strain of unprecedented government bail outs and there is great uncertainty about the shape the recovery will take.
All this makes existing strategic plans irrelevant and the normal budgeting process seemingly impossible. Yet boards, CEOs and senior executives still want ways to predict and plan for the future, as well as monitoring performance.
So, how can you develop a useful budget in the face of all this uncertainty?
The answer is to develop a banded budget. This is a style of budget that reflects the possible range of outcomes based on different scenarios for key assumptions and business drivers. Rather than producing a single figure for, say, monthly profit, the banded budget provides a range of expected profit based on different scenarios. Actual performance is then tracked against this range and analysis focusses on the underlying assumptions.
This style of budget is useful in the face of uncertainty as it focuses much more on the drivers of the business and sources of variance to monitor performance and drive decision making. It also avoids the risk of an above budget result leading to a false sense of security.
How do you create a banded budget?
The process is actually relatively simple and similar to traditional budgeting processes. The key steps involved are outlined below.
- Scenarios. Start by developing a range of possible scenarios at a macro level. Consider the various possible outcomes for social and economic recovery and describe how these will affect your organisation, your competitors, the market and wider economy.
- Holistic approach. Ensure your analysis considers the impacts on the whole organisation, not just financial. This means considering how governance might need to adapt, how operations and process will be impacted, any organisational structure changes and identification of new risks.
- Key Drivers. Identify those aspects that will have the greatest impact on your business and the ability to deliver on purpose. Key drivers could be things within your control, such as production levels, or less controllable, such as underlying demand.
- Modelling. Building on the above analysis, develop a detailed financial model that can be used to project cash flow, profit & loss and the balance sheet. This must be an integrated model where all three financial statements work together.
- Assumptions. The model should have the ability to include variable assumptions about each of the key drivers and the major impacts of each scenario developed. Consideration should also be given to any linkages or dependencies in the assumptions. For example, a significant increase in sales will most likely also require an increase in some costs. It is important to select a suite of assumptions that represent the most likely range of outcomes, without creating an overcomplicated list.
- Timeframe. The purpose of a banded budget is to indicate the general direction the organisation is moving and identify emerging trends as they develop. It is not like the traditional static 12-month budget. It evolves over time as new information emerges and assumptions are updated. It is an 18 to 24-month rolling forecast that can be regularly updated by reviewing and changing the underlying assumptions, as required.
- Monitor. Given its purpose and nature, monitoring a banded budget is more focussed on the underlying drivers and assumptions rather than the specific outcome. Whilst it is important to monitor current financial performance to ensure viability, it is also important to determine where the organisation is heading and how market changes are likely to impact the business. The focus for monitoring and management reward is on how well trends are being identified and the tactics used to respond, rather than specific financial targets at a point in time.
These unprecedented and uncertain times are creating new and significant challenges for business leaders. Many of our traditional approaches and models are being rendered obsolete or unworkable. Many may feel the budget process is far too challenging in the current environment and be tempted to ignore it or avoid budgeting all together. This could leave the organisation exposed and at greater risk of financial distress emerging.
Utilising a banded budget approach enables the board and executive to gain focus on the important drivers impacting the business, identify emerging trends and keep ahead of potential financial distress. This could be one of the most important tools you can use for planning, implementing and monitoring your COVID-19 recovery and transformation strategy.
About the author … Dr Jason Talbot is the Managing Director of Graphite i2i, a specialist boutique management consulting firm which provides business transformation, performance improvement, M&A, strategy and governance services to medium and large organisations. The company’s highly innovative business assessment and transformation methodology, 6C Framework, provides CEOs and Boards with a holistic view and understanding of their businesses capabilities, allowing them to readily identify areas in greatest need of attention or determine where future opportunities lie.
Should you require assistance developing a budget in the face of uncertainty:
Call Jason on 0450 049 444