The Budget Process: Squeezing the Lemon

In the current "Fog of War" business world, where many references were lost after the pandemic, inflation is growing, supply chain and workforce disruptions are everywhere, and customer behavior is changing dramatically, the normal budgeting process doesn't work well.

Many companies use a budget system to set goals for the executives to achieve the company's business objectives.

The typical way is to define the global business objectives?and break them down to the different executives accordingly with business units and the company structure, linking the executives' incentives with?each specific goal.

The primary assumption is that if everybody has a specific goal, the right incentive, and a detailed tracking system, the company will achieve its business objective with the more negligible risk possible. So it looks like a matter of having a very detailed plan, commitment, and accountability.

Another common assumption is that the only thing the company has complete control of is its costs, so often, the emphasis is on creating cost control mechanisms.

Since the budget usually looks for a time horizon of a year, it also creates a habit of looking only for the "lower hanging fruits". The problem is the word "only" because the executives frequently become addicted to just pursuing the more straightforward and quarter local goal.

This mindset also drives us to look more internally than look to the client's perspective, losing opportunities by not realizing soon enough new market limitations and new ways to create real competitive edges by adding value to the market. Luckily, in this new crazy world, there are plenty of new limitations to remove.

This way, the budget planning process looks like "squeezing the lemon", a considerable effort that often creates only incremental improvements, if not just an accounting game that plays with numbers.

As Yishai Ashlag said in his book "TOC Thinking":

"In business, as in sports, the focus is on winning. But great teams and great companies are about more than delivering immediate results, they develop their unique core philosophy that makes them great over time. When the emphasis is only on winning by delivering numbers, companies are likely to compromise of their core philosophy and its application."

On top of it, there is an important thing: the detailed business objectives breakdown is accurate just in the planning phase. As the execution starts, all budget elements will vary: price, volumes, capacity, expenses, costs, inventories, cash flow, etc.

Since there is variability and dependence, the optimum proportion between those elements will also change. As engineers?know very well, in a nonlinear system, in order to optimize the system, it is mandatory to sub-optimize some subsystems. And the regular accounting reports don't show it.

Sometimes, even making a SWOT analysis or implementing OKRs, the managers think about it in isolation as a collection of good ideas that can help the company to increase its results.

Thus, we need to think globally, with a relentless focus on what dictates our ability to have success. So, instead of going into endless details and forecasting, let's take a step back and look at the system as a whole, focused on your real "asset", what makes the clients buy from the company.

Focus on the actual asset helps the company to capitalize on it or protect it with the correct value proposition. It also brings focus to the company's operation and the way to deliver this value to the market.

Only then is it time to define the governance tools, including the budget.?

A budget needs to be built to show the cause and effect that connect results with the performance of the business constraints, avoiding the illusion of controlling uncertainty. In other words, it is much better to realize the variability of assumptions on the plans and define buffers properly than to force certainty on uncertainty.

Using the Throughput Accounting approach of the Theory of Constraints, it is possible to build a budget system focused on the leverage points of the business model, understand the right way to define buffers, and realize the appropriate control points for execution.

This way, the company can align specific goals and responsibilities with global business objectives.

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