Our team typically engages with finance and FP&A teams when they are in the midst of change. Often times, processes are being revamped or new tools are being leveraged, built out, and deployed. One of the top questions we are asked revolves around the tension behind how much detail should be included in a budget. Specifically, what is the true impact if our clients make things simpler? Or conversely, what is the impact if our clients make things more complex?
It is certainly true that organizations that buy better tools, and leverage better processes, typically find efficiency. That efficiency almost always centers on speed and accuracy. The tension remains, however; do our clients choose to reinvest the time saved to increase complexity (and potentially make a better plan/forecast) or do our clients maintain the level of complexity in order to speed up the process?
First, an organization needs to resolve itself around the priorities of management. Is a completed budget, delivered on-time worth 5-10% variance plan to actual? Or, is a nearly perfect plan to actual worth a slower and more expensive process along with the associated delays in the availability of a finalized forecast or budget?
Decision Theory includes the concept of the expected value of perfect information. That is, what would an organization or user be willing to pay (or trade) in order to get perfect information for an ideal plan or forecast. The pragmatic truth is that organizations incur costs and spend value pursuing perfect information but that increased quality of information is quite often outweighed by the eventual returns that the better plan is able to earn. Said differently, many organizations pay thousands of planning dollars in order to ensure that they don’t waste a few hundred operational dollars during their next budget cycle.
As budget teams strive to add detail in the pursuit of accuracy, it shortens the reaction time managers have in adjusting their teams and its processes. Additionally, it leaves little opportunity for the FP&A teams themselves to evaluate their technology, processes, and models in order to back-test the previous cycle, learn lessons from the past, and make adjustments for the future.
So, with all of that said, how detailed does your budget need to be? The bad news is that there is no one size fits all answer that applies to each and every organization and situation. The good news is that there is a right answer for your organization and your situation!
First, decide how important certainty is to your stakeholders. Stakeholders can include private equity in small companies and formal investors in larger companies. Plans, forecasts, and budgets and the financial statements generated by your FP&A team are the most important tools that these stakeholders will use in their own decision-making processes. If detail is required by your stakeholders then detail is what should be provided even if it incurs a larger cost.
Second, consider your reporting obligation as it relates to the legal status of your enterprise. There are baselines of detail that must be met from a legal perspective. Make sure that you don’t create more problems down the line by oversimplifying the financial statement outputs required from your organization.
Third, consider carefully the cost that your FP&A and Finance teams incur in getting increased certainty. Make sure, especially as new tools and processes come online that your teams have the ability to refine their models, back-test the prior plans, and plan effectively for the future.
Fourth, think carefully about materiality when you think about applying more focus and pursuing greater amounts of detail. If you find that salaries are the largest driver of your expenses, then your plan may be well served by further insight and greater levels of detail. Conversely, if you have only a small percentage of depreciation relative to your other expenses, then greater detail will likely not be worth the effort or justified by the time and expense.
Finally, if you are in the midst of change, implementing a new planning and budgeting tool and find yourself still trying to answer the question of how detailed your budget should be, we can help. Check out our performance management advisory services.
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