Best Practices for Flexible Budgeting

Flexible budgeting can be the answer to achieving business agility – if you avoid this one mistake

Digital transformation. Global pandemic. Generative AI. Supply chain disruption. Shifting consumer behaviors. Geopolitical uncertainty. Climate change impacting raw material availability. In a world where things may change fast from any direction, companies need to retain agility to adapt to change. For many companies reevaluating financial planning in this reality, flexible budgeting has become attractive. 

In this article we’ll explore the advantages and disadvantages of flexible budgeting, best practices to succeed with flexible budgeting if you decide it’s for your company, and the one key mistake to avoid.

Flexible Budgeting Versus Static Budgeting

Budgets used to be static. There was a process, usually starting 3-5 months before the start of the new year, which resulted in a fixed budget broken down by department. The process might be top down or bottom up, or a combination of the two, but the result was fairly close to etched in stone.

Static budgets give everyone involved a reassuring sense of closure. Once closed, they can forget about budgeting and analysis until next year. All anyone has to do is keep to the budget. The trouble is that this approach leaves companies fumbling when things change. 

The more that dynamic shifts appear probable from many directions, the more companies start looking for flexibility and the agility that comes with it. Paradoxically, the increase in agility can make companies more stable, because instead of floundering they have a plan when they need it. 

With flexible budgeting, organizations account for the unexpected by creating a budget that can be adjusted depending on what actually happens with revenue and expenses during the year, reviewing both during the year, and then adapting the budget as appropriate. This requires thinking through different scenarios during the budgeting process.

Advantages and Disadvantages of Flexible Budgeting

If nimbleness is essential for businesses now, and flexible budgeting is part of that, why aren’t they universal as a finance best practice? The answer is that they aren’t right for everyone. As with everything else, there are tradeoffs. Each company needs a budgeting approach that fits its needs. 

Disadvantages of Flexible Budgeting

Flexible budgeting comes with a price, exacerbated by the fact that it often takes a few iterations for companies to find the best framework and rules to best manage a flexible budgeting process within their organization. Whether it’s worth going through this learning curve depends on whether the advantages outweigh the disadvantages for your specific business. Negatives include:

• More work. Creating a flexible budget means thinking through how different scenarios might impact connected line items and the overall budget. It requires more financial modeling. More thought and analysis. In a word, more work.
• Ongoing work. With a static budget, the work is over once you’ve closed the budget. With a flexible budget, that’s not the case. There’s no point having a flexible budget if you don’t keep track of changes inside and outside the company to analyze how they’re impacting your budget and what you might need to alter.
• The risk of overcomplication. It’s possible to go too far down the flexible budgeting rabbit hole. There’s no logical requirement to stop thinking out different scenarios and possible implications. The calculations can get impossibly intricate if you don’t have guardrails on your process. 
• Excels won’t cut it. Some teams still budget using Excel spreadsheets, and with static budgets that’s possible, even if it does risk errors, data silo disruption and a tangle of formulae. It’s not possible once you start working with flexible budgeting. You need a platform designed for modern finance needs.
• The fear that departments will get too flexible. Many companies worry that with flexibility will come less accountability, with departments too willing to change their budgets on the fly. This can build up across an organization to cause real loss and confusion.

This last concern in particular is one that comes up frequently in discussions about flexible budgeting. As we’ll discuss later, it’s a real worry – but also an opportunity in disguise.

Advantages of Flexible Budgeting

On the other hand there are, of course, advantages to flexible budgeting. Whether the advantages outweigh the disadvantages depends on the structure of your organization, its size, its financial situation, its culture, and its goals. 

• Adapts to changing circumstances. The primary advantage of flexible budgeting is, of course, the flexibility. If you’re in an industry which is likely to see dynamic changes in the near future or frequently which will probably require you to adjust your budget, this factor may weigh heavily.
• More accurate over time and in expectations. When the pace of change really has sped up dramatically, a year (or more, given that the high-level framework of a budget is usually closed well before December) can simply be too long to lock down resources. Flexibility can allow a company to be more accurate in its spending priorities, and in controlling expenses. It can also give the company a more realistic mindset, so that departments are not shocked and affronted if they need to adjust mid-year. It’s been clear from the start that that might happen.
• Encourages departments to raise flags early. If something changes significantly during the year, there’s usually a specific department or two affected most and earliest. Knowing that the company works with a budgeting method that allows for flexibility encourages departments to communicate when issues arise, and advocate for their needs. This gives leaders transparency into the reality in their organization, and enables them to make decisions that take the broad needs of the company into account.
• Impetus to find the technology and platforms that streamline resources. Although shifting from a landscape of ever-increasing Excel spreadsheets to a dedicated FP&A platform like Firmbase represents an investment, many companies find that as well as enabling far more efficient and comprehensive budgeting processes, it has benefits far beyond the budget. As factors within and without organizations become ever more complex, centralizing data in a platform designed for the purpose becomes not just better but necessary. It means the FP&A team can automate processes and calculations to eliminate errors and increase the number of factors under consideration, while freeing up human resources for analysis and strategic finance initiatives.
• Can lead to increased control over internal capital allocations. With static budgets, department heads tend to feel that they own all the money in their budget. In fact if they haven’t used it all close to the end of the year, they may rush to do so. But this leads to inefficient use of capital which should be invested back into the business elsewhere. With flexible budgeting, control over where such funds are spent becomes centralized in leadership.

This last point sounds like it’s the opposite of the fear that departments will take too much initiative into their own hands. How can flexible budgeting risk lack of control, as we discussed in the disadvantages, but also offer increased control, over internal capital allocations? We’ll answer that in the final section. Before that, let’s run through best practices. 

Best Practices for Flexible Budgeting

Like everything else, there are best practices in flexible budgeting. Here are important things to incorporate into your process:

• Fixed versus variable. Ensure you’re clear on the definitions your organization should use for fixed versus variable expenses, and build your budget accordingly. 
• Be strategic about the scenarios you plan for. Consider a sensible range of scenarios which would impact your business enough in ways to require adjusting your budget from the top. Think about the Covid-19 pandemic; there were businesses which had a “zombie apocalypse” scenario plan sketched out which enabled them to pivot fast when the pandemic hit. Adapting an existing, agreed plan is much easier and faster than coming up with a new one while the ground is shifting under your feet.
• Limit the scenarios you’re planning for. Choose a useful range of scenarios, relevant to your business. Resist the temptation to go down the path of exploring every possible permutation. The point of flexibility is the ability to adjust as you go. Build limitations into the process. 
• Link line items up thoughtfully and strategically. There’s a knock on effect when things shift, but some areas are more tightly connected than others. Make sure your budget scenarios reflect this realistically. 
• Communicate the meaning of flexibility to your company. It doesn’t mean departments can change things as they go. It means the leadership may require them to make changes if it’s necessary for the company, and the organization expects everyone to be working together for the good of the wider business. That’s what success looks like in your company and everyone needs to know that and be rewarded for acting accordingly.

It’s this last point that is so crucial, but which is often overlooked by companies considering flexible budgeting. In the final section we’ll look at why it matters so much, and how you can avoid making this common mistake.

Flexible Budgeting: How to Retain Control While Adding Agility

To succeed in flexible budgeting, companies need to find the right balance between control and autonomy. Firstly, there must be accountability for the budget. One individual must own the budgeting process and the decisions about when, why and how budgets may be adjusted during the year. 

It might be a CEO or CFO, or depending on your organizational structure may sit elsewhere. The key is to choose the right person in your company, and make sure that everyone knows who it is. 

If there’s a fire in a warehouse or data center and the company needs to dip into its resources meaning there’s less to spend on marketing or sales, that’s for the decision maker to determine and communicate. If there’s more money coming in than anticipated, the decision maker analyzes the broad situation and makes a thoughtful capital allocation. Maybe the money will be reinvested in the business in a completely different area from the area that saved or generated the money. Make sure that revenue generating unit gets credit and is rewarded. Make it clear that doesn’t come with control over the funds. 

Communication is absolutely essential throughout the company. Every department head must understand what flexible budgeting means for their organization. It’s vital to build this around a shared culture and vision of contributing to the business goals, rather than fighting for departmental resources. 

At the same time, departments must be encouraged to act with autonomy within the bounds of the budget they have. When you’re looking at existing operations and there are no significant changes, they should feel empowered to act and know they will be supported in their decisions. 

For this to work, they need to understand the parameters and vision that guides the company and should also guide them. To quote Sam Freedman, “The tactical adeptness required in government flows from strategic clarity.” Companies are no different. When strategy is clear, both autonomy and control are possible in balance. 

This is a reflection of company culture, but there’s nowhere that it’s more important, or more evident, than in flexible budgeting. 

Learn how Firmbase helps FP&A teams create budgets, run forecasts & analyze important financial insights.