Speak with virtually anyone involved with the annual budgeting process and they’ll tell you that it’s painful: Time consuming, difficult, error prone, and based more on politics than on valid economic assumptions. The worst part, however, is that the budget is viewed as obsolete almost as soon as it’s complete. Despite these challenges, most corporations have stuck with the traditional budgeting process as they don’t believe they have anything better to replace it with.

Fortunately there are companies who have scrapped the traditional notion of a budget and have replaced it with something much more useful. They still have a budget, but their updated budget has been streamlined. No longer do they put themselves through the long and difficult budgeting process; rather, they focus on creating a budget that is far less detailed but that communicates the key ideas of the planning process.

The Goals of Budgeting

The annual budget and the budgeting process serve a number of goals. Among them are:

Link operational plans from multiple departments. The budgeting process, as opposed to the actual budget, fosters communication and enables the coordination of business unit and departmental activity across the organization to support the achievement of strategic plans.
Capital allocation. One of the key aspects of the budget is to decide where a company will employ its resources. Strategic plans around new products and markets, research and development, production capacity and other dimensions will feed directly into the budget.
Performance monitoring. The control of capital and the early detection of deviations from establish plans have also been key elements of budgeting. Reports comparing the variance of actual results from budget are a standard component of management reporting packages.
Compensation rewards. Many executives have a portion of their pay linked to the attainment of budget goals. The targets established through the strategic planning process are incorporated into the budget and ultimately into the annual performance plan for these executives.

In subsequent posts I'll discuss the problems with traditional budgets and the opportunities to create a more effective budgeting process.