What is Strategic Budgeting?
The budgeting process is an integral part of any business. The budgeting process is ubiquitous and underlies almost every decision in the corporate world. In fact, critics of the budgeting process argue that the process takes too much of the managements time. The management typically spends 25% to 30% of four months of their time in the budgeting process.
Despite the huge amount of time and resources being spent in the budgeting process, the results have been less than encouraging. The root cause of this suboptimal performance is the fact that the budgeting process is short-term in nature and generally disconnected from the overall strategic objectives of the firm. This is the reason that over the years, the field of strategic budgeting has become more prominent. Details regarding strategic budgeting have been explained further in this article.
Part of an Integrated Process: Currently, the budgeting system across the world is based on the past. This means that budgets are prepared based on what they were in the previous year. However, the strategic environment of a firm could have changed drastically in the past year. For instance, new technologies could have emerged or new competitors could enter into the business.
New technologies and new competitors typically do not become a threat to the business in the first year of its existence. However, this is the best time for the organization to mount a defense by allocating funds. Most firms are unable to do so because the budgeting process is considered to be operational and is typically disconnected from the longer-term strategic plans of the organization. This changes when the principles of strategic budgeting are taken into account.
Strategic budgeting is supposed to be aligned with and derived from the longer-term strategic plans. This is the reason that strategic budgeting would immediately realize a threat to its competitive positions and would start allocating funds.
Use of Balanced Scorecards: The problem with budgeting is that the evaluation takes place purely from a financial point of view. In many companies, people managing budgets are only rewarded when they are able to save some amount from their allocated budget. There is a floor and ceiling which is set up for every expense type. The problem with this approach is that the focus is purely financial and ignores other factors.
For instance, cutting advertising costs may appear to be profitable in the short run but is likely to lead to the loss of market share in the long run.
Strategic budgeting tries to remedy this problem by involving the use of balanced scorecards.
Various parameters are listed in the balanced scorecard and when costs are reduced, their effect on other strategic objectives is also considered. This provides the organization with a more holistic view of cost reduction strategies as opposed to the one-dimensional view of aggressive cost-cutting.
Multiyear Objective: The process of budgeting is inherently short-term in nature. This is because the results derived from budgeting are valid for a maximum period of one year. Strategic budgeting tries to get rid of this shortcoming of the budgeting process. Strategic budgeting is not linked to a short-term one-year goal. Instead, it is linked to a multiyear objective that is derived from and hence is aligned with the strategic plan.
Forward-Looking: The budgeting process is often criticized for being backward-looking. This is because budgets for the current year are derived from the previous years budgets. However, with the advent of strategic budgeting, this has changed. Strategic budgets are usually zero-based budgets. This means that instead of using the previous year as a base and then building from there, the budget is built from scratch every year. As a result, the budget is usually aligned to strategic objectives and hence tends to be forward-looking.
Higher Empowerment: Traditional budgeting is a centralized process. Higher-level managers decide the budgets and then cascade these budgets to units or plants. However, this is not how strategic budgeting works. Strategic budgeting is a more inclusive process whereby the opinion of ground-level personnel is also considered. The ground-level personnel is briefed about the long-term objectives of the firm and ideas are sought from this personnel in order to be able to achieve the objectives.
Generation of Internal Funds: Strategic budgeting is also linked with the strategic plan to raise capital.
Organizations that think long-term chart their growth path well in advance. As a result, they are aware of when they will need funds in order to accelerate the growth of their business. This is where strategic budgeting can help them raise funds internally.
If the firm is able to manage its cash flow in such a way that the funds needed for growth are available at the proper time, it will be able to avoid taking on some very expensive debt. This is the point where strategic budgeting intersects with other areas within finance.
Hence, it can be said the strategic budgeting plays an important role in the long-term financial management of the firm. Therefore, it is important for companies adopting strategic financial management to also adopt the strategic budgeting process.
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- Strategic Finance and Capital Structure
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- Strategic Finance and Sustainability
- Strategic Finance and Technology
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