Why is the budgeting process so difficult?
Yep, it’s budgeting season for many organizations around the world. And personally, I’d rather have hot coals poured down the back of my trousers.
I thought I’d do a quick series of blogs on why the budgeting process is so difficult. We all have to slog through it and I’ve never met anyone – ever – who enjoys it. Now, I'm leading up to one way of reducing the pain significantly; but more on that later. First…
I’m a Brit which, if you believe popular stereotypes, means I spend my evenings sitting the pub drinking warm beer and arguing about life’s imponderables. Who is the greatest footballer ever to have lived? What is the best sports car? If you had a million Pounds, what would you spend it on?
These questions may not really matter, but they are complex. In fact, the reason these questions provide hours of entertainment in pubs up-and-down the country is precisely because they are complex. To answer them, you have to have an idea of what makes, say, a sports car great. There are multiple factors that affect your opinion; looks, performance, handling, heritage…
Everyone makes different trade-offs between looks and, say, handling, between performance and heritage and that’s really the fuel for those wonderful debates over a beer.
Erm… the question was why is budgeting difficult?
I know. But stay with me.
The same logic applies to budgeting season. Each person in the organization has taken a different journey through life. Each has a different set of goals and drivers, a different set of filters through which they view things.
So, when putting forward a budget proposal, a manager has first to decide what their goals are for the coming year – and there are usually a few – and then figure out what resources and initiatives they need to hit those goals. So far, so good.
But of course, you’re not going to get the whole amount you asked for, are you. That would be too easy. No, you get the feedback from on-high: Reduce Your Budget by 25%.
So now you have to make trade-offs. And just like in the pub, the trade-offs are not simple or trivial. It turns out that we humans are not very good at this kind of thing. We didn’t evolve to hold complex scenarios with multiple criteria and a myriad possible solutions in our brain. Cognitive neuroscientists have given this limitation a name: bounded rationality.
Worse, you’re not budgeting in a vacuum. Your boss, and her boss, and her bosses boss, and your peers, and your hair stylist and your local convenience store clerk all seem to have an opinion on where and how you should make cuts.
This is messy. It’s fraught. It’s stressful. In a word, it’s complex.
Good Priorities Reduce Complexity
I said I was going to lead in to a pain-killer: here goes!
The root of much of the pain here is that everyone has a different view of what the trade-offs should be. The vast majority of organizations have, at best, vague statements of goals and priorities. There is seldom any guidance on the relative importance of the different goals and so everyone makes their own best guess.
So here’s a radical idea. Actually, it’s not radical at all, it’s common sense. Why not set corporate priorities and then define how those priorities trickle down into the different departments?
There is a really good tool for doing this – it’s called analytic hierarchy process, or AHP for short. It’s used around the world for project prioritization and budget allocation, but not enough people know about it.
The idea is simple: break your decision down into manageable chunks, define your priorities (in the form of criteria) and test each budget proposal / initiative / budget line against those criteria. This gives you a score which you can then use to work out a “benefit to cost” ratio – this is key as it allows you to deliver the most benefit (as measured by your explicit priorities) for the least cost.