Asking some managers to imagine running a company without budgets is like asking them to imagine the Earth without gravity. The universal law that grounds everything is gone, and the universe floats freely in chaos. Mind-blowing.
Let’s travel back in time to when budgets were compiled by hand or calculated on a mainframe computer. Mainframes were as large as a bus but dumber than your smartphone. Later, personal computers arrived on everyone’s desks. They were soon connected to the “world-wide web.” This allowed employees to do their shopping during work hours. Then came a form of remote communication via talking pictures called Zoom.
While all this technology blossomed, companies began managing more with metrics and scorecards. Building projections and modeling scenarios could be quickly completed. This allowed rolling forecasts and activity accounting.
Join me as we explore managing without budgets in a world you might call . . . The Twilight Zone.
The Purpose of a Budget
Bjarte Bogsnes explained how Scandinavia’s largest company kicked out the traditional budget in an article titled The Art of Managing Cost Without a Budget. In this article, he points out that most companies ask for a budget to do three things:
- Forecast: This is what the company thinks will happen in the future. It can be replaced by rolling or dynamic forecasting.
- Set Targets: These are the levels of performance the company wants to achieve. They are inspiring and cause the company to stretch beyond what would happen naturally in the forecast. These can be replaced by key performance indicators (KPIs) or objectives and key results (OKRs).
- Allocate Resources: Many consider this the main purpose of the budget. However, a static budget struggles to optimally allocate resources in a dynamic business environment. These allocations must be made by decision criteria when reaching key targets or responding to trends.
This article will discuss how these three processes can work together to replace a budget. Some companies can work better without a budget than others. For example:
- Very small companies that have only a few employees that work closely together
- Rapidly changing companies
- Companies that operate in a very uncertain environment
- Companies with strong internal communication and coordination between teams
- Companies with strong communication and coordination across the vertical layers of the company
- Companies that currently manage via rolling forecasts or frequent goal-setting processes like OKRs
Budgeting may have developed its prominence because financial information was easy to track. It was already tracked by accountants. The budget became the one tool we had to manage performance because of information limitations. It’s much easier now to gather, analyze, and communicate a wide variety of information through a variety of systems. Some of what we used to try to manage with budgets may be better managed via these other systems.
Managing Without Budgets
Budgeting is replaced with more frequent and less detailed planning cycles. Preapproval via budgets is replaced with approval based on achieving targets or goals. Large expense decisions are made when the company reaches a target or the business environment triggers the need for a strategic response.
Frequent Forecasting and Projections
Rolling forecasts can be paired with traditional budgets or replace traditional budgeting. Higher-level strategic planning may be more continual or triggered by significant events.
The ability to quickly change plans and run projections requires constant information gathering. Some of this will be done by top leaders and communicated down through the company as decision guidance. Some information is gathered in lower layers of the company and communicated to top leaders. There must be processes for this information flow.
Frequent forecasts require less detail. You may forecast the same amount of detail for a shorter length of time than traditional budgets. The remaining time periods are forecast in less detail.
You may decide to run fewer alternatives for the short period of near-term detailed forecasting. You still need to run high-level projections for continual strategic planning. Shorter-term forecasts and decisions are chosen from and informed by these projections.
I said earlier that working without budgets may better fit rapidly changing companies or ones in highly uncertain environments. Projection accuracy for these companies greatly diminishes over longer projection horizons. Projections and planning may have to be done for shorter periods (e.g., 1–3 years instead of 3–5 years).
Managing with Metrics
Forecasts are management’s best estimate of near-term results. Managing means making decisions to improve results over time. This is done via metrics and goals.
Top leaders can define key performance indicators (KPIs) that are crucial to company success. These metrics would be:
- Financial and non-financial metrics
- Both leading and lagging indicators of performance
Companies using traditional budgeting may already use KPIs. These KPIs are often set based on the budget for the next year. Metrics in a rolling forecast environment can be set by:
- Continual improvement: Teams are expected to better their metrics each performance cycle. Management must clarify how much improvement is expected each cycle. This must be balanced with periodic resets for reasonableness based on changes in market conditions.
- Industry benchmarks: If industry information is available, you can set metric targets based on competitors. The target can be a fixed number based on past industry performance or relative to peer performance (e.g., “be in the top quartile of industry performance”). One benefit of this over continual improvement metric-setting is that market conditions likely impact both the company and its competitors. It’s not an adjustment that management needs to determine.
- Peer benchmarking: Peer benchmarking is like industry benchmarking but done between teams within the same company. For example, a company could compare key metrics for each of its retail stores or bank branches. A team’s performance would be judged based on where it ranks compared to other teams or the trend of its ranking.
Another performance management system to consider is objectives and key results (OKRs). OKRs are generally set quarterly. The key results metrics define and help evaluate whether the objectives were achieved. The process of setting OKRs involves strong communication and collaboration between teams. They also tend to be stretch goals. All of this fits well with processes that allow operating without a budget.
Performance evaluation reporting includes:
- KPI scorecards
- OKR scorecards
- Balanced scorecards
- Trendline reporting for the company, industry, or both
- Industry and peer benchmarking
How are bonuses and incentive compensation set without budgets? One option is to set them based on achieving goals and metrics. This comes with many drawbacks. They include:
- Gamesmanship
- Limits vision to the metrics
- Metrics can’t tell the whole story of performance
I go into more detail about this in my KPI and OKR courses.
Another option is to use a profit-sharing program for bonuses.
Compensation programs are complex and sensitive. They have to be specific to the culture of each company. It’s hard to make a blanket recommendation.
Resource Allocation
Without budget allocations, will managers spend with abandon? Not when their performance is measured via metrics. Their interests are actually better aligned with company profitability. The “use it or lose it” mentality means budgets are meant to be fully spent. Few budgeting processes have good methods with which to scale expenses with revenues. This is especially true when the revenues and expenses occur in different departments. Metrics do a better job scaling expenses with return than expense allocations alone.
How do managers decide what to spend and in what ways? They need clear guidance from top leaders. They need to understand strategic priorities. They have more freedom and flexibility to make decisions based on their observations of market conditions.
What about big capital expenditures? I contended earlier that their profitability should be measured outside of the budgeting process. You should assess whether they are good investments for your company at any point in the year. You may make an early preliminary assessment. This is then followed by a final detailed assessment just before the decision to proceed.
If a large capital expenditure is a good investment, then the next decision is when to implement it. This is often made in the context of financial and staff capacity. The prioritization and queueing of projects often occur in the budget process.
Without budgeting, projects can be prioritized or reprioritized at any time or throughout the year. Project queuing is conducted in the continual longer-term planning. The authorization to begin implementation is made in the rolling forecast process. All of this is informed by the information flow described earlier and by monitoring metrics.
Internal Control
The control environment needs to be redesigned when working without a budget. To be honest, budget-to-actual detect controls are weak. As the year progresses, the budget is less accurate. Budget-to-actual reports are more a testimony of my inability to foretell the future than indications of reporting issues. I may look closely at the variances early in the budget year. I look more closely later in the year at month-to-month changes in actual performance.
Detect controls sometimes arise because we don’t take the time to define risks and develop prevent controls. Instead, we rely on a catch-all detect control. It reminds me of when Justice Potter Stewart said he couldn’t define pornography but instead claimed, “I know it when I see it.”
The best prevent controls are automated. Good prevent controls mean good systems design. It’s easy to get a minimum viable system in place and call it “good enough.” There is pressure to do this in the face of the rapid rate of change and stretched staffing of fast-growing companies. Prevent controls must be required for minimum viability when lacking mitigating detect controls.
I said earlier that smaller companies might be good candidates for operating without a budget. Smaller companies have less separation of duty, which increases risk. However, company leaders and owners have more visibility into transactions and processes, which helps mitigate risks.
If you decide to forego traditional budgeting, you may need to do more frequent checking of processes. Errors are more likely in new and changing systems. Forecasting and planning processes may lack strong controls. They now need strong controls since they replace the budget controls. Also, confirm that staff decisions are aligned with the intent and direction of senior management. If not, then communication may need to be improved, or you may need to go back to traditional budgeting.
Boards Without Budgets: Carver Policy Governance
I’ve worked with two types of companies without budgets. One type was small startup companies. Their greatest analysis need was short-term cash flow planning. An annual budget is meaningless if you run out of cash in six months.
The other type was nonprofits whose boards utilize Carver Policy Governance. I’ve been on Carver boards of a church with $1 million in donations and an agency with $40 million in revenues.
In Carver, boards don’t approve budgets. Some nonprofit board members may think this is the only important vote they hold all year. It’s tough to convince boards they don’t need to approve a budget. Sometimes, grantors or accreditation bodies require that boards approve budgets. In that case, Carver boards “affirm” budgets.
Carver still says a budget may be a tool for managers. The staff at companies at which I was a board member had budgets.
How does a Carver board manage financial risk and set strategy? They have one set of policies that says what they want the company to accomplish. They also have policies for financial activities that would be unacceptable. This may include setting metric minimum and maximum levels. Management may need to get board approval for major resource allocation decisions, like buying real estate.
When setting these policies, the board is forced to explicitly state what would cause a budget to be unacceptable. It makes expectations explicit, rather than rejecting a budget and then explaining the reason for the rejection. The board may still find an issue so as not to “accept the budget when they see it.” They then should add this to the policies.
Being on these boards caused me to think about what’s approved in a budget. Is it:
- Specific revenue dollars and expense amounts?
- The relationships between amounts (e.g., gross margin, return on equity)?
- Certain key outcomes, which may be non-financial (e.g., nonprofit mission goals, customer satisfaction, employee satisfaction, units sold)?
For most companies, what leaders and board members want most is to achieve metric targets or ranges (i.e., the second two bullets). You don’t need budgets expressed in dollars to manage this. The processes shown in this lesson show that you may not need budgets for resource allocation and expense control.
If the ideas of this lesson have intrigued you, check out the Beyond Budgeting Roundtable site. They champion a more empowered and adaptive form of management. For them, this means no more command and control annual budgets.
Pros and Cons of Operating Without a Budget
Many managers and finance staff likely fantasize about being free of the time and struggle required to build and report against a budget. Companies without budgets can capture strategic and operational benefits. However, operating without a budget requires that many other processes be in place.
Operating without a budget is not right for every company. Those who do switch to working without a budget will also need to mitigate some new challenges.
Benefits of Operating Without a Budget
- Greater agility: Annual budgeting is replaced with more frequent planning cycles. Planning and implementation may also be event driven. Does the command and control of traditional budgeting help you control actions? Yes. But that’s not the goal. The goal is to match actions to the environment. For that, budgets give the illusion of control.
- Improved communication: Directives from the budget are replaced with more guidance. Top leaders have to inform other leaders and employees of strategic plans. Departments and teams must coordinate more with each other. Important information needs to be constantly communicated through the company to inform frequent planning cycles.
- Greater autonomy and empowerment: Direction from top leadership is provided more by guidelines than by directives. Short planning cycles don’t allow large sets of directives. Middle management and employees make decisions based on the guidelines and goals. This can provide greater job satisfaction.
- Improved coordination: Fewer top-down directives lead to more coordination between teams to achieve goals. The increased communication noted earlier also leads to better coordination.
- Less “use it or lose it” spending mentality: Budget allocations are replaced with metrics and goals. Teams don’t have pots of money they feel compelled to spend to get a similar pot of money in the next annual budget.
Cons of Operating Without a Budget
- Transition time and money: The transition to operating without a budget will take time and money. It entails a restructuring of systems, staffing, and culture.
- Less alignment: Managing via guidelines versus directives leads to less top-down alignment. There is less control by senior leaders and more education by them.
- Potentially greater chance of and magnitude of errors: To reverse a well-known phrase, “With great responsibility comes great power.” Staff have the authority to make poor decisions that cost money.
- Greater autonomy and empowerment: I choose to use the same wording as I used in the benefits to show that not all people respond the same way to greater autonomy. Some will be more frustrated and have lower job satisfaction. Some people like more guidance than less. They may fear more responsibility.
Check out my Better Budgeting course to learn about other budgeting alternatives. Get step-by-step guidance on how to improve your business’s budget. Save time and stress while putting together the pieces for a profitable future.
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