Near-Term Budgeting Strategies in the COVID-19 Era

This research is adapted from which provides financial planning and analysis leaders options on how to adjust budgets for short-term resource allocation decisions.

Many executive leaders are asking themselves this question: How should we revise our budgets in response to COVID-19? Budgets that were approved prepandemic are now obsolete, and organizations are pivoting to budgeting solutions for the near term.

The budget pressures created by COVID-19 have led to major cost cuts to increase short-term efficiency and bolster liquidity. In an April 2020 Gartner survey of more than 300 global finance leaders, 26% anticipated zero-basing their budgets due to the pandemic, while 40% were undecided. Against a backdrop of increasing volatility, zero-based budgeting (ZBB) consideration is being driven by the desire for a structured approach to identify cost reduction opportunities.

In fact, most organizations have already experienced some of the quick wins of a ZBB-like, cost-cutting exercise (see Figure 1). These actions were taken with the intent to set spending levels based on necessity in the near term and will likely be one-time, circumstantial trade-offs.

However, a ZBB approach to budgeting is more than just a cost-cutting exercise; it eliminates extraneous expenses that are not aligned with strategy and instead shifts funds into activities that drive sustainable growth. ZBB efforts should be built on an understanding of current market and operating dynamics, as well as the long-term implications of decisions taken today, all of which may not be ascertainable at the moment. Overhauling a major financial management process at an accelerated pace, or as a one-time effort when key performance indicators are in flux, can be more detrimental than helpful.

While introducing ZBB may seem like a logical step, many executive leaders simply may not have the time or the bandwidth to plan and implement it.

To support efforts targeted to allocating resources quickly and efficiently in a volatile environment, there are three budget strategies that organizations can consider:

Regardless of the option selected, they all provide the following benefits:

• Allocation agility

• Driver-based insights and a simplified cost structure

• Frequent performance updates

• The right level of detail needed for decision support

• Better working capital management

Since these options are designed to be flexible and provide decision support, it is recommended that executive leaders use them only for resource allocation and not for target setting.

Some organizations may need to temporarily switch to a more tactical quarter-by-quarter process to more quickly assess short-term financial needs. A quarterly budget entails minimal structural changes to the existing budget as it shortens the time horizon, but tends to retain the existing data structure. Expectations for how this modified budget should be used to inform decisions needs to be made clear to stakeholders.

Executive leaders should ensure their direct reports perform a quick review of quarterly performance and guide these key budget decisions for the following three months:

A quarterly budget approach may, at first, seem effort intensive, but there is an opportunity to reduce budget data volume and complexity to speed up budget preparation. One proven way to simplify the budget data structure for faster decision making is by consolidating cost categories. In a volatile environment where quick visibility into cost drivers is a necessity, streamlining cost accounts into cost categories allows for better budget assumption management and focuses performance conversations on key drivers and categories of spend.

This approach can be leveraged to get greater visibility into profit and loss (P&L) performance in the near-term to take quick action when forecasts start to diverge from performance. It will be useful for industries that have been hit particularly hard, and must rapidly assimilate market changes and reformulate plans in real time. The most value will be derived if the process is supported by operational metrics tied to strategic business outcomes, and the ability to project key operational drivers and validate assumptions across the forecast horizon.

The following are sample criteria based on materiality and volatility that can be used to identify business-critical line items suitable for a rolling-forecast-based budget:

Putting together a criticality dashboard (see Figure 2) will create transparency on the organization’s financial position and can also serve as an anchor point for emerging scenarios. Executive leaders must delegate their direct reports to create a criticality dashboard that can help in evaluating the budgeting modelfor the organization.

Using forecast ranges for the rolling forecast in this option can capture several estimated outcomes which encourages proactive planning. The biggest challenge of range-based forecasts is how to determine the low and high ends of the range to not make the range so broad that it inhibits decision making, or too narrow that the estimated likely outcome is missed. To determine the high and low ends of the range executive leaders must ask themselves:

• What value is so high that the true estimate will most likely fall below it?

• What value is so low that the true estimate will most likely fall above it?

Then they can collaborate with their direct reports to determine the probability of the estimate falling within that range.

Near-term scenario-based budgets provide organizations with the capability to manage uncertainty by providing alternate views of the future against which strategies and resource allocation decisions can be tested and will work best. This is particularly geared toward organizations that can develop concrete macroeconomic and business scenarios and model the implications of each scenario on their businesses. As complexity in organizations increase, scenarios help to build flexibility in the budget structure. Scenario-based budgeting can seem impractical since the process to create one annual operating budget is already lengthy, and building multiple budgets may seem unrealistic. However, having a coordinated planning effort and agreeing on a baseline scenario to develop budgets help executive leaders make quick decisions. The following two tactics can help reduce the burden:

• Flexible costs, which can be adjusted during the year

• Variable costs, which vary with the speed of production

• Costs that represent a sizable proportion of the overall budget

• , such as an observed 10% drop in revenue

• , for example, when there is a 75% chance of a 10% drop in revenue

• , such as when revenue will continue to decline over the next three quarters

Good triggers should be forward looking, measurable, material, unbiased and frequently updatable. Using predefined triggers limits the amount of time spent debating whether a scenario occurred that justifies switching to a different budget. The ability to shift to a scenario-based budget helps organizations to seize opportunities and to make faster, more confident decisions in the midst of the type of uncertainty, volatility and complexity present today.

Choosing the most appropriate near-term budget option for the organization can be critical to providing flexible resource allocation decisions as organizations continue to face disruption in these unprecedented times. Executive leaders need to prepare for continuous near-term resourcing decisions, which is difficult to do under typical budget management.

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Changing business priorities in the wake of a recession means that executive leaders must reassess the services and capabilities they use as resources. Zero-based budgeting is a tool to rightsize budgets and shift resources toward value-added activities aligned to reprioritized business outcomes.

Zero-based budgeting is increasingly imposed by executive leaders to rebudget existing costs because business cases are needed only for new project spending. But the way many organizations apply ZBB to cost often misses the realization of business value. Without value, cuts must continue.

To respond to the impact of the COVID-19 spread, organizations are under extreme pressure to cut costs while maintaining performance. This research helps executive leaders establish a structured approach to identify, evaluate and communicate cost-saving trade-offs for their functional budget.