Budgeting – Why do companies do it?

Before jumping into the best practices, it is important to understand why companies do the budgeting exercise –
either yearly or on a more frequent basis. Is it just to complete one more activity that needs to be done every year.

Definitely not, but budgeting process allows the entire organization to come together and focus on the goals they
want to achieve, draw action plan to achieve the goals and detail the same in financial terms. This helps them to walk
out with what the next year looks like for them. It also facilitate in presenting a summary of the same to the various
stakeholders depending on the type of the organization – investors, board of directors, top management, employees,
customers and prospects on how the business is going to be sustained and grown.

Based on the needs, the organization should figure out the methodology of budgeting process i.e. how detailed the
process should be carried out, at what frequency, who in the organization should be involved etc. The budgeting best
practices and the supporting technologies in the form of CPM products can help in a long way to determine the
effective budgeting process.

Budgeting Best Practice # 1: Budgeting part of the corporate culture

Budgeting should be adopted as part of the corporate culture. It should not be just a chore of top management and
finance, but there should be organization wide commitment. This should be an exercise where senior management
sets realistic targets and require department managers to produce their own plans and tie incentive compensation to
their ability to manage their business and achieve their goals. Availability of effective CPM tools help in the process,
as an important ally and overcoming obstacles to adoption of budgeting as part of the corporate culture.

Budgeting Best Practice #2: Synchronize the Strategic and Operating Plans.
Finance and top management create long range strategic plans that align to goals and major initiatives. Now the
budgeting process is where the detailed operating plans are drawn out. Both the strategic and operating plans have
to be synchronized and related. The operating plan should not be totally different from Strategic Plan. This ensures
that the line manager’s work towards the same goal optimization set out by the top management. Ideally the
operating plan should flow from the strategic plans.
CPM solutions from SAP offers modeling capabilities that can ensure a clear alignment of the strategy defined in the
SAP Strategy Management, and from there moving to Planning in SAP Business Planning, thereby ensuring
synchronization between strategic and operating plans.

Budgeting Best Practices # 3: Both Bottom up and Top down

Many organizations do one of the two approaches. Some organizations plan completely top down, where the top
management provides all the goals and targets of what needs to be achieved. The outcome of that is a detailed
budget just driven by those top goals. But this could be very unrealistic, since the business unit managers may not be
able to commit to this.

Few other organizations do the pure bottoms up approach where the whole organization does a detailed budget,
flowing through the bottom up chain of command, and this again may not achieve the management goals
satisfactorily.

So the best practice approach would be to have budgeting done with both scenarios and finally the bottom up plan
goes and meets the top down (target) plan, marrying them together. Now this could lead to lot of disagreement within
the organization due to constraints on time and effort for doing both approaches. This is where SAP Business
Planning can enable and fasten the whole process of multi scenario budgeting. With capabilities to reconcile two
different categories of budget, organization can concentrate more on the planning and strategic aspects, rather than
on the manual reconciliation and co-ordination. Since the whole solutions are empowered for the business user, it
provides lot of flexibility to model different planning model, easily and flexibly.

Budgeting Best Practices # 4: Relative vs. time trend budgets

This is a very important best practice in the current competitive and environment. Lot of effort is spent in creating
budgets that are what I call ‘time trend’ budgets. These are just numbers fixed in the budget based on a certain %age
growth over the previous year. But by doing this the opportunities that exist beyond the current framework of the
business are not leveraged.
The best practice approach would be to start the entire process from a relative perspective, with respect to the
industry and market benchmarks. If it is revenue planning, there should be comparisons of what the market size is
and the growth opportunities for the market. In the bottoms up plan approach each regional sales manager can
contribute to how much of the market share his/her region can derive and what are the new opportunities that exists
that the competitors have explored or yet to explore. In the top down plan, the top management may identify the
strategies to grow the business. If it is supply chain planning, the companies may benchmark against industry metrics
to achieve the best results. The plan should not be just to beat the last year internal metrics but to look at the industry
benchmarks metrics, in order to drive the company to excellence. This best practice promotes business or
entrepreneurial thinking to every manager, rather than doing the budgeting as a financial centric activity that is usually
completed as a transactional task.

The vision of SAP CPM offerings is to promote the business manager from a mere transaction manager to being a
strategic advisor. Also the predictive analytics capabilities in SAP CPM offer analysis of data based on their
relationships. Predictive analytics can be leveraged to plan for sales volumes based on GDP/ income levels/
purchasing power of the market segment or another example would be ascertain the maintenance cost based on
the available oil prices.

Budgeting Best Practice # 5: Collaborative Planning

Similar to carrying out a real time activity, where every department co-ordinates with each other seamlessly, to run
the business operation, Budgeting should also be collaborative across the various functional departments. Sales
planning created by the Regional Sales department should seed the production capacity planning of Operations
Manufacturing department. The shortfall in capacity should lead to investment and capital expenditure planning that
would be prepared by Projects department, and this in turn will lead to cash flows and funding plans. There would be
parallel streams to recruit new people that will lead to Workforce Planning by Human Resources department, and
also to prepare marketing planning. The whole process should be iterative and co-ordinate through a seamless flow.
When an organization spends time in putting up a collaborative budget in their planning cycle, results are bound to be
very effective since all departments have converged into an integrated plan for the next year. The below chart explain
the collaborative planning:

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SAP Business Planning product allows for very effective collaborative planning through the concept of Business
Process flow. The users can approach the product from a process centric approach rather than a function centric
approach. The entire annual budgeting process is modeled as a business process flow and the different departments
can collaborate and create multiple iterations of budgets.

Budgeting Best Practice # 6: Adaptable and continuous planning

Every plan becomes successful only when it is flexible to change based on the internal and external events. Annual
budget needs to constantly reviewed and forecast created at least every quarter if not at a shorter frequency. This will
facilitate to incorporate the impact of the events, especially in this fast changing business environment. Best practices
recommend rolling forecasts coupled with annual planning, to ensure the business plans reflect the latest scenarios.
This will also ensure identifying new opportunities for business that did not exist when the original budget got
prepared.

To support such an event based, adaptable and continuous planning, it is very essential to have software solutions
that can support the change. Also the more important consideration is that the solutions should be business user
enabled, in order to implement business plan change rapidly. SAP Business Planning solutions with its very flexible,
easy to use administration capabilities fits this need very well. It is truly enabled for the business user. In addition the
insight module within the solution allows for automated variance analysis that helps in identifying the events that is
causing the variance. This is achieved through existing transactional, market and operational data that is loaded into
the database that may reflect the dependant events.

Budgeting Best Practice # 7: Driver based planning

The planning exercise is all about assumptions. As the exercise is futuristic, the models are created with assumptions
that the top management or the LOB managers perceive to achieve the goals. Drivers are nothing but the pillars
based on which assumptions are determined. So from a best practice standpoint, it is very important to build a
template or planning model that sits on top of all the drivers. The LOB managers set the values for the business
drivers in a budgeting process, based on which the complete budget is determined. The advantage of such an
approach would be to make sure the budget is supported by the strong drivers that are essential for a particular
business.

Examples for driver based planning are the following:

To determine the outbound freight cost, the driver based model would consider the drivers such as Sales volumes,
fuel cost, maintenance cost per vehicle, and efficiency of transportation volumes per vehicle. The cost would be built
based on these drivers and as the driver values changes, the freight cost would change. So the advantage of this
approach is not to recalculate the cost manually when there is an increase in fuel cost or change in the sales volumes
forecasted.

Another driver based model would be to determine the workforce cost. The drivers for the workforce cost would be
built based on the Headcount FTE (full time equivalent), Salary rates, merits and overall company revenue to
determine some bonus element. Again through this approach, the model is developed comprehensively based on the
way the company runs the business, and it is designed as a driver based planning model.

SAP Business Planning offers powerful driver based planning capabilities. The solution offers predefined driver based
models for revenue, expense, headcount and capital expenditure planning. Also as the solution is business user
owned and managed, it allows powerful, flexible and easy to use administration interface to build the driver based
models.

Budgeting Best Practice #8: Budget Material content only

Maximum budgeting time should be spent on areas that would have significant impact from a revenue, cost or profits.
It would not be prudent to invest time to detail out an expense line item that is just 0.001% of the revenue, except that
it may be captured as a total figure. Budgeting time should be spent to model on very high impact items such as
revenue, the main expense that contributes to say > 10% of the overall cost. This will also allow opportunities to build
strategies to control cost or enhance revenue.

SAP Business Planning solutions offer the concept of line item detail functionality which allows for free form detailing
of certain low value expenses, to ensure lot of time is not spent on modeling these expenses comprehensively in the
planning models.

Budgeting Best Practice # 9: Timely and accurate

This is a no brainer. As in every process, budgeting exercise should be carried out in a specific timeframe to ensure it
is relevant. It is not a good practice to start budgeting for the year after the year starts. Many companies ensure the
budgeting for the next calendar year is completed in the November timeframe of the previous year. This allows for a
well laid out business plan for the following year. Of course this budget needs to be revisited continuously and should
allow for modifications.

The accuracy is another aspect. Especially for the higher impact elements, it is important that the numbers are
accurate. When building a driver based model, the calculations that results from the drivers should be accurately
modeled to get the right results. This is an important consideration where using spreadsheets could be a misery and
SAP CPM solutions would help.

SAP Business Planning solution is the best suited tools to ensure timely and accurate budgeting are carried out.
Since it is business user owned and managed, the model is built by the business users who know how the
calculations should work or how the data should be used. Also through the Business Process Flow tracking
capabilities, the budget coordinators can ensure that the budgets are prepared in time.

I hope you benefited by reading the above budgeting best practices. It is time now to go implement these best
practices at your end in whatever form using SAP Business Planning offerings. SAP is greatly focusing on this area
with multiple CPM offerings to enable best practices in budgeting and reporting.