The Case Against the Annual Budget

Budget season is under way in most organisations. It will absorb a significant share of senior management attention for the next two months and produce a document that is materially inaccurate within a quarter.

The exercise persists because the alternative appears to be chaos. It is not the only alternative.

The process rewards negotiation, not accuracy

When next year’s resources depend on the number you submit, the rational behaviour is to submit a number that protects you. Budget holders pad. Finance applies a haircut. Everyone knows both are happening.

The output is a figure that reflects negotiating positions rather than expected performance. It is then used as the baseline for variance analysis all year, which compounds the error.

Use it or lose it destroys value every December

Annual allocation with no carry-forward creates a predictable spike in low-value spending at year end. Budget holders who underspend are penalised in the next cycle, so they do not underspend.

This is entirely rational behaviour produced by the mechanism. Organisations that allow limited carry-forward, or that separate the funding decision from the annual calendar, see the spike disappear.

Forecasts and targets should not be the same number

A great deal of confusion comes from asking one figure to serve two purposes. A target is what you want to achieve and should be ambitious. A forecast is what you expect to happen and should be accurate.

When they are the same document, the forecast inherits the ambition and stops being useful for planning. Separating them costs very little and immediately improves both.

Rolling forecasts beat annual precision

A quarterly rolling forecast covering the next four to six quarters gives you a continuously current view without the annual set-piece. It is less accurate at the twelve-month horizon and considerably more accurate at the one-to-two quarter horizon, which is where most decisions actually get made.

It also removes the artificial significance of the December boundary, which no customer or supplier observes.

What to change first

You do not have to abandon the budget to improve it. Two changes deliver most of the benefit.

Separate the target from the forecast, and say so explicitly. Then allow limited carry-forward on discretionary spend so that underspending is not punished.

Both are small procedural adjustments. Both change behaviour immediately, and they make the larger question of whether you need an annual budget at all considerably easier to consider next year.