The Answer Series: Is Budgeting at a High Level a Best Practice?

I receive questions all the time from people looking for a best practice or simply to answer a pressing question. One that has come up (a lot) recently is “What is the best level to budget at?” The debate being centered on budgeting/planning at a low or high level. Here is my answer:

Budget at the same level you’ll capture your actuals in – but make it easy.

Here's The Context

There are two reasons why this question tends to come up. The first is that some consulting firms have advocated for budgeting at a summary level (I’ll explain why) and the other is some Budgeting/Planning FP&A software vendors discourage budgeting at a detailed level (I’ll explain that too).

The fundamental argument put forth for budgeting at a summary level is a pretty simple one. “It’s easier.” I’ll detail later why that is not true, but that’s the rationale in a nutshell. Beyond that, advocates for budgeting at a high level or summary level talk about “materiality”. As in “Does it really matter if it’s Airfare expense or Hotel expense? It’s all Travel expense, don’t get lost in the weeds, it’s not material.” That can sound smart, but we’ll see the trap that puts you in.

Is High Level Budgeting Really Easier?

I’m going to use an illustration focusing on Operating Expenses (since every reader should be able to relate to that) but the same arguments and analysis hold equally true for Sales & Revenue, CapEx, Cost of Goods Sold (COGs) and every other element of the P&L.

If your company has 100 general ledger accounts for Operating Expenses, and the budget template only calls for 20 lines to be budgeted, on paper that would appear to be easier. In fact I’ve heard from some Finance teams that took this approach that they believed they’d be heralded as heroes “for eliminating all that work.”

The problem with this approach is it introduces a fundamental disconnect between how the business is budgeted, and how the business is run. That ultimately creates more work, not less.

Here’s a simple illustration. I’m a Cost Center Manager with a $1MM budget. If I’m expected to manage to that budget I need to understand how my Actual expenses are coming in and how they’re tracking with what I Budgeted. If there is a mismatch between the two that makes my life harder. And it’s actually the detail that helps me understand what’s happening in the business and manage it.

For example, if the General Ledger Accounts related to Travel include Lodging, Airfare, Meals, Ground Transportation and Miscellaneous; then knowing which of those accounts a variance is coming from will help me manage my business. For example, if most of a $25K variance is in Airfare and we’re in the middle of an oil crisis with airfares rising every day, that’s one thing. If on the other hand 95% of the $25K variance is coming from Miscellaneous, then I have a very different issue on my hands.

Here's the problem. If my budget is only at the summary level “Travel” I really have very little visibility into the variance, and that makes it that difficult to explain or manage. I need someone to start pulling invoices and cobbling together a picture of the spending, then start talking with my managers about it and see if I can come up with an explanation.

You’ve actually made my job harder by not allowing me to budget at the same level the Actual results come in at.

Now this is where someone might say, “Hold on. Who said anything about not allowing people to budget at a lower level, they’re free to do so if they want.”

That creates more work for budget holders as well, here's why. If the corporate template (e.g., “Travel”) is at a higher level than the G/L Accounts and the way a department wants to manage the business (Lodging, Airfare, Meals, Ground Transportation and Miscellaneous) then that department needs to create their own template. Then they need to summarize the budget detail in order to populate the Corporate template… and make certain the two templates tie out. That's more work, not less.

There's also the recurring problem of Reporting Actual Expenses versus Budgeted Expenses.

It’s very common for the Finance department to produce a financial report for each Cost Center comparing Actual spending to Budgeted spending. This normally comes right out of the financial reporting system. The problem is if actuals come in at a detailed G/L level and the budget in the reporting system has been captured at a summary level, then there is a fundamental mismatch and therefore the business value of this crucial monthly report is greatly reduced -- and possibly even negated.

The Not So Hidden Role of Software Vendors

FP&A Software vendors may encourage budgeting at a summary level because it’s easier to implement, and because they are often working in concert with management consultants who advocate this approach.

Another common reason why at least some FP&A Software vendors may push to budget at a summary level is that creating budget templates… binding them together through relationships… and tailoring them to accommodate needs of different business units, divisions or functional areas, often requires custom coding and scripting. That can get expensive. Knowing this, they may choose to discourage budgeting at a detailed level to keep implementation costs down.

Regrettably, this often results in a

“one-size -fits-nobody” template that forces budget holders right back to excel.

The Key – Make It Easy

Here’s a simple solution. Make it easy for a budget holder to budget at a detailed level OR high level and automatically synch the two. If you’re still budgeting in Excel, that last sentence may conjure up this image in your mind:

Let me get technical for just a moment, since the solution is technical (at least in part). The solution requires what is known as a reverse algorithm. This enables you to overcome the CIRC REF! error you may see if you’re still using Excel for budgeting. The reverse algorithm allows you to enter data in a template and have it cascade down automatically to the lowest level OR budget at the lowest level and roll it up automatically – or budget at any level in between. Really.

The benefit is everyone gets what they want. The team in Corporate Finance that cares only about a summary level budget gets what they want, and the budget holders who want (and need) the details to manage the business get what they want.

Another part of “making it easy” means replacing coding and scripting with drag ‘n drop configuration. If it’s overly complicated to create screens and templates for multiple business units or functional areas (because they all need special coding and scripting), then it simply won’t happen. On the other hand... if a non-technical person can leverage drag ‘n drop configuration, then getting people what they want and need becomes a whole lot easier.

So for all the reasons discussed here, the real answer to the question "What level should we be budgeting at" is "Budget at the level you capture Actuals in."

For a quick summary For and Against budgeting at a summary level you can refer to the table below:

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