Gartner Research

Improve Cost Insight Using Multimodel Budgeting

Published: 23 September 2020

Summary

Current budgeting models fail to provide insight into costs, which can negatively affect the organization’s revenue and profit growth potential. This research explains why multimodel budgeting is critical for executive leaders to improve their understanding of costs.

Overview

When facing economic headwinds, the most successful executive leaders maintain continuous visibility into cost information, make unbiased midyear resource reallocation decisions and make decisions based on an explicit understanding of cost relationships.

The budgeting process of such organizations involves varied and dynamic processes for different corporate functions. As the underlying characteristics of the function (such as degree of automation and workflow variability) evolve, so does the organization’s approach to budgeting. The result is a set of budgeting models that are customized to address the specific ways in which traditional budgeting underserves particular parts of the organization.

Key Findings
  • Current budgeting fails to generate insight into costs. As a result, organizations may sacrifice up to one-fifth of their revenue and profit growth potential.

  • Many organizations use a single budgeting model for their entire organization; 70% adopt two or fewer budgeting models. The most common model is historical budgeting.

  • Organizations that use more than two budgeting models (a multimodel budgeting approach) have significantly higher levels of insight into their costs than the organizations that use only one or two models.

  • Multimodel budgeting may seem inefficient and burdensome, but it enables a higher degree of process standardization and uses fewer resources at the corporate center. Additionally, key stakeholders find it more valuable.

Recommendations

Executive leaders responsible for budgeting, planning and forecasting should work with their direct reports to:

  • Prepare a business case for multimodel budgeting by demonstrating its superiority over traditional budgeting in delivering improved cost insight without burdeningthe existing teams and processes.

  • Identify the most appropriate budgeting model for each corporate function by evaluating the degree of judgment required, degree of automation, advisory orientation, workflow variability and growth alignment.

  • Create a plan for implementing the selected budgeting models by identifying the new or expanded people, process and technology capabilities that staff will require.

  • Reduce business disruption and ease the burden on the organization by phasing the introduction of new budgeting.

This research has been adapted from which helps financial planning and analysis (FP&A) leaders improve their understanding of costs by adopting a multimodel budgeting framework.

Budgeting has always been and continues to be a painful, long and cumbersome process. On average, organizations take 93 calendar days to complete the annual budgeting process, with two to three iterations during the cycle. A major concern for organizations is that investments of time and effort in budgeting are not paying off. In fact, the current budgeting approach hurts more than it helps organizations. Gartner’s research shows that organizations sacrifice, on average, 17% of their revenue growth and profit growth potential due to the limitations of their current budgeting approaches (see Figure 1).

Figure 1. Revenue and Profit Growth Potential Sacrificed Due to Budgeting

Figure 2. Three Manifestations of Low Cost IQ

When done correctly, budgeting improves an organization’s cost IQ. A high cost IQ is characterized by the following:

  • Continuous insight at the corporate center into current cost information as it relates to growth drivers, not cost centers

  • High confidence in current-year spending decisions that impact the future

  • Explicit understanding of cost relationships (for example, in environments with high-cost allocations)

  • Ability to make unbiased midyear resource reallocation decisions

When considering a multimodel budgeting approach, executive leaders must understand the suitability of models for different conditions. For example:

  • This includes a mix of top-down and bottom-up budgeting based on historical data.

  • A forecast from the previous year is used to set the current year’s budget one to two quarters in advance.

  • This model uses rule-of-thumb principles about operational costs that are used to estimate revenue and expenses.

  • This method uses a detailed line item and/or activity-level review, requiring each expense to be justified for every new period.

Yet, these tools are not utilized in the best possible manner. Often, organizations limit themselves to using one or two budgeting models, failing to properly match its budget models to a function’s operating attributes. This can have a negative effect on the organization. Research shows that organizations can nearly double their cost IQ by adopting a multimodel approach.

The majority of organizations in the top quartile of cost IQ use a multimodel budgeting approach (see Figure 3).

Figure 3. Percentage of Organizations With Top-Quartile vs. Bottom-Quartile Cost IQ

Organizations phase in multimodel budgeting in various ways. Some choose to do so gradually or in waves, while others change their budgeting process in one move. Regardless of how organizations approach budget transformation, executive leaders must ensure that their direct reports use the organization’s collective expertise to phase cost drivers into the new budgeting model. For instance, when phasing in a driver-based budget, it is crucial to model how events affect general and administrative (G&A) workloads. Meanwhile, when incorporating rolling forecasts into the budgeting process, executive leaders must be selective about the details that are to be included.

Figure 4. Overview of WWE’s Forecast Model

When determining the most appropriate budgeting model for each corporate function, companies should consider the nature of work performed by the function using the following five attributes:

The use of historical, DBB or ZBB for any given function will depend on these attributes (see Figure 5). Rolling-forecast-based budgeting is largely independent of corporate function characteristics.

Figure 5. Nature-of-Work Attributes Important to Each Budgeting Model

Conclusion

Organizations using more than two budgeting models (multimodel budgeting) have a significantly higher level of cost insight than organizations using only one or two models. Contrary to popular belief, multimodel budgeting does not require additional resources and is perceived as more useful by stakeholders. Executive leaders should determine which model to use for a business unit or function by assessing its operational context.

Recommended by the Authors

In response to the economic uncertainty unleashed by COVID-19, executive leaders are rethinking budgets for the rest of 2020. This research provides options to adjust budgets for short-term resource allocation decisions.

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.

With COVID-19 shutting down major portions of economies, enterprises need to lower their costs. Budget cuts are coming and executive leaders must start preparing now. This research shares what CFOs are planning, and what executive leaders should do to respond.

About This Research

This research is based on extensive qualitative interviews with over 70 FP&A leaders, as well as data collected from 79 organizations.

Endnotes

2018 Gartner Budget Process Benchmarks Survey

Sydney Water Value-Based Budgeting Model,” March 2017.

Work-Centric G&A Budgeting Models (Ford Motor Company),” July 2016.

Driver-Led Rolling Forecasting (WWE),” December 2016.

Analysts:

Finance Research Team

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