Ep. 131: Marco Otti - Budgeting Revisited

Contact Marco Otti: https://www.linkedin.com/in/marco-otti/

Budgeting Revisited: https://sfmagazine.com/post-entry/may-2021-budgeting-revisited/

FULL EPISODE TRANSCRIPT
Mitch: (00:00)
 Welcome back to Count Me In, IMA's podcast about all things affecting the accounting and finance world. I'm your host Mitch Roshong and this is episode 131 of our series. For today's conversation my co-host Adam spoke with Marco Otti about possible solutions in different approaches to budgeting. Marco is a group controller who acts as a finance business partner to support the decision-making of Autoneum, the global market leader in acoustics and thermal management. In their conversation, Marco discusses some of the common issues with traditional budgeting and explains why CFOs need to rethink how they plan and execute their budgets. Keep listening as we head over to their conversation now.

Adam: (00:50)
So let's start by talking about some of the issues with traditional and better budgeting. Why change?

Marco: (00:56)
Yes, why is innovation in budgeting needed, right? I mean, as a group controller, I contribute to our company's annual budgeting, monthly forecasting and three-year financial planning process, and I often ask myself, how can we as management accountants do a better job at budgeting, right? Kind of process be simpler or different. I'm sure most listeners have been involved with the budgeting process in one way or another. Maybe ask yourself as well, what do you consider the most significant barrier to improving or changing your budgeting process? There can be many barriers of course, for example, organizational attitudes towards budgeting, time, cost, inflexible IT systems, or the process being controlled by another group/department, or maybe you think there are no barriers at all, then that's great. One thing to remember is that traditional budgeting is still used in the maturity of companies. At the same time, many of these organizations identify agility as their strategy, which is quite surprising because traditional budgeting is too rigid to support agility well. And if you read Kaplan and Norton, they say that the ineffectiveness of many budgets also comes from the fact that almost 60% of organizations don't link budgets to their strategy and only 25% of managers have incentives linked to the company's strategy. Most of us are aware of the limitations of traditional budgeting. So it can be a very time-consuming exercise with limited value, as assumptions are quickly outdated. Also decisions are often made too early and other to senior level. And based on my own experience, having been involved in a budgeting process, the issue with traditional budgeting is really the amount of work compared to the benefit. I mean, having annual and detailed discussions with cost centers can be quite time-consuming and usually the complaints come from us, the finance function, finance organization who manage and execute this process. So depending on how lean and improved your process is, it can be an efficient exercise as well. With better budgeting you can substantially reduce the planning effort, for example, with less meetings, less reporting requirements, more top-down guidance, shorten the process to maybe one or two months every year. However, process improvements are still a continuation of the traditional budgeting approach and does not bring fundamental changes of instruments.

Adam: (03:30)
So then what are the essential functions of budgets and what are they used for?

Marco: (03:34)
That's a good question because, the functions and what budgets are used for, are quite relevant and important, like translating your company strategy into targets, which refers again to the strategy execution, Kaplan and Norton are talking about. Budgets are, if you will, the tactical implementation of the strategy, they are about resource allocation, which again, starts with developing and validating the company strategy. Therefore, I would say you cannot just remove the budget with its functions and manage your costs and business because planning is still important to coordinate activities, in your own organization. As an example, let me share some of the different functions the budget has at my company, Autoneum. We use the budget for setting absolute targets for the year and to support the performance management throughout the year, for example, every month. So the budget really serves as a reference point for performance and based on many assumptions, it gives a prediction of the next year and how we plan to control costs. Also it is used for resource allocation and managing continuous improvement initiatives. In any organization, traditional and better budgeting is really a mix and let's say a compromise of some of these and other functions.

Adam: (04:57)
Okay, then, so in the context of traditional budgeting and VUCA environments, how did your company respond to the crisis last year?

Marco: (05:04)
Yes, I mentioned agility before, of course, in a VUCA environment, like in 2020 with the COVID-19 pandemic, traditional budgets were not very useful to compare performance against because they were basically irrelevant by the end of the first quarter. So how did we respond? On the top line we planned for different scenarios and updated them weekly. In terms of costs, we used the most recent rolling forecasts, which are updated monthly. And in discussions with the business unit locally agreed on how to best cut costs. In some cases we instructed some top-down adjustments, based on the revenue levels. So for a time really stopped focusing on a budget, right, and shifted the attention to the monthly forecast and came up with intermediate targets based on the circumstances. This is also something to think about when you put yourself in the shoes of the decision makers. What did you or your company do to respond and manage costs during the pandemic? Did you empower your local teams because they know best how to manage costs. Or on the other hand, did you centralize decisions as much as possible because in a crisis there is a need for strong leadership, right? Actually, I mean, this spectrum of self-control versus command and control is relevant when thinking about new budgeting approaches. You can manage costs with detailed annual cost budgets or increase autonomy and flexibility by using absolute or relative KPIs, or even no targets at all. Of course, this then needs strong company values and a clear direction.

Adam: (06:45)
What are the possible solutions for more business agility and changing to different budgeting approaches like beyond budgeting?

Marco: (06:52)
Actually this question, was the reason why the president of the IMA Switzerland chapter, Hessel Brouwer and myself, reached out to CFOs and academics in Switzerland to learn from their experiences of moving to more modern and agile budgeting techniques and then also publish an article in strategic finance. One of the main ideas of the beyond budgeting theory is to separate the budget functions as outlined before. The key budget functions, are target setting, forecasting, and resource allocation. So instead of having one compromised number for all these functions, you would in a first step separate targets from forecasts and from resource allocation. With that, you would have three different numbers serving different purposes. A key tool is forecasting or rolling forecast, which supports the ongoing planning and forecasts are used for the purpose of better decision-making and not as a target or application for resources. Forecast should reflect the best estimates with as little details as possible and be again, decoupled from targe...