Budgeting and forecasting

Cue 1 Budget built from activity, each line traced back to a driver.

AMARA 00:00 Most budgets are last year plus a percentage. What is wrong with it?

NADIA 00:05 No line in it can be explained. Ask why the training figure is what it is and the honest answer is that it was that last year, and the year before, and nobody now in post knows the original reason.

Cue 2 Fixed, variable and stepped cost behaviour on one graph.

AMARA 00:21 What replaces it?

NADIA 00:22 Activity. Clients, shifts, units, cases. Costs then follow from the activity, so every line has a driver attached and can be defended against challenge.

Cue 3 Stepped cost jump at the ninth member of staff.

AMARA 00:32 Which cost behaviour catches people out?

NADIA 00:34 Stepped costs. One supervisor covers eight staff; the ninth requires a second supervisor, and that cost arrives whole rather than in eighths. A percentage built budget smooths straight over it and the jump lands as a surprise in month seven.

Cue 4 Original budget, flexed budget and actual, in three columns.

AMARA 00:50 Monthly review. The service is over budget.

NADIA 00:53 First question is whether it did more than the budget assumed. A budget built for a hundred compared against actuals for a hundred and forty produces an arithmetic difference, not a variance. Flex it to actual activity, then compare.

Cue 5 Forecast diverging from budget as an early warning gap.

AMARA 01:08 And if it remains over once flexed?

NADIA 01:11 Then split price from volume. More units used, or each unit costing more. Those are different problems with different owners, one operational and one procurement. A total figure alone produces an argument rather than a decision.

AMARA 01:26 Forecasts in many organisations land back on the budget.

NADIA 01:29 Then they are not forecasts. The budget is the plan. The forecast is the current honest expectation. Where they differ, that gap is the most valuable figure in the pack.

AMARA 01:41 And closing it on paper?

NADIA 01:43 Removes the only early warning anybody had. The problem still arrives, later, and by then nobody can act on it.

Cue 1 Profit budget beside cash budget, same plan, different question.

AMARA 01:51 Why do I need a cash budget as well as a profit budget?

NADIA 01:56 Because they answer different questions. The profit budget says whether the plan makes money. The cash budget says whether you survive doing it.

AMARA 02:06 What goes in it that is not in the other?

Cue 2 Cash trough in month seven, visible three months ahead.

NADIA 02:10 Timing, and the lumpy items. When customers actually pay rather than when terms say they will. VAT quarters. Corporation tax. Annual insurance. The van you are buying in March.

AMARA 02:21 And what does it show me?

NADIA 02:24 Your trough. The month in the year where the balance is lowest. A business that knows its trough three months out arranges facilities calmly and cheaply.

Cue 3 Lumpy items landing: VAT quarter, tax, insurance, equipment.

AMARA 02:34 And one that does not?

NADIA 02:36 Discovers it on a Tuesday, borrows expensively from whoever will move fastest, or cannot borrow at all. Same business, same plan, entirely different outcome, decided by whether somebody built the cash budget.

AMARA 02:49 Zero based budgeting. Worth it?

Cue 4 Zero based budgeting rotated across areas rather than applied everywhere.

NADIA 02:51 Selectively. It is genuinely good at finding spending nobody can explain any more. It is also expensive in time, and doing it everywhere every year turns it into ritual.

AMARA 03:02 Meaning?

NADIA 03:03 People learn to write a justification for the number they already wanted. Rotate it instead, onto whatever has drifted longest or grown fastest.

Cue 5 Four budget behaviours with the process fix beside each.

AMARA 03:12 Now the uncomfortable part. Everyone pads their budget.

NADIA 03:15 Of course they do, and it is not dishonesty. A budget that turns out generous is comfortable and one that turns out tight is career limiting. They are responding rationally to the incentive.

AMARA 03:28 And the March spending spree?

NADIA 03:30 Same thing. If underspending is punished with a smaller allocation next year, spending the remainder is the correct response to the system you built.

AMARA 03:40 So how do I fix it?

NADIA 03:42 In the process, not the people. Build from activity, so a padded line has to name a driver that does not exist. Allow carry forward, so honest underspend is not punished. And separate the budget you plan with from the number you judge people against, because when those are the same document you have asked somebody to set their own exam.