Budgeting During Black Swan Events
Two years ago, right around this time in spring, you may have found yourself optimistically planning your business budget, but little did you know that the rug was about to be pulled out. And after the dust settled–and it was a lot of dust that required a lot of masks–there was one prevailing feeling: we should have known.
A black swan event is an occurrence in human history that has the potential to inflict severe global economic consequences. Characterized by their extreme rarity, they are defined by being outside the average scope of predictability; however, in hindsight, the general sentiment exists that leaders should have been prepared despite the event’s unlikelihood. In other words, the world agrees that black swan events are always unknowable, but a dusty playbook should have been within arm’s reach on the shelf.
The Unknowable 2020s
Back in early 2019, businesses across the globe were hard at work planning their budgets for 2020. They looked back at past performances, refined their financial goals, and prepared to execute. You know what happened next. Enter the coronavirus pandemic, which wreaked long-term havoc on global markets and the economy.
It’s safe to assume that not many businesses got it right when it came time to compare estimates to actuals in 2020. By 2021, most firms had tossed out the previous years’ forecasting models, correctly attributing their faulty estimates to the pandemic’s disruption. But a year later, not much has changed. So much so that some businesses are not even using 2020 or 2021 as baseline data in forecasting. Instead, they’re referring back to 2018 estimates and 2019 results to identify the last normalized financials.
But today, recent global events have caused even more economic uncertainty. It seems that as one crisis ends, the next begins. Again, the pressure is on for those in the forecasting hot seat. One encouraging fact is that all pandemics eventually end, and considering that certainty, most indications point to Covid’s diminishing economic impact. But just when we thought it was safe to get back to business, a new threat has materialized: inflation.
At the time of this writing, the annual inflation rate has hit a 40-year high, marking February 2022 as the most significantly impacted month since January of 1982. And every sector of the economy is being hit hard. Gasoline, copper, corn, and home heating oil are just a few commodities that have skyrocketed. And when commodities rise in prices, generally the cost of goods and services are not far behind.
So where does that leave us? If we know anything about black swan events, it’s that they introduce an incredible amount of uncertainty into the marketplace, making it uncommonly difficult to forecast and budget. But there are steps companies can take today to help ensure they don’t wind up in that same spot, ruefully looking back on the previous year’s forecast. If the pandemic taught businesses anything, it’s that they need to prepare for future black swan events, whatever they may look like. In other words, get to writing those playbooks. And one tip – business agility should be your central theme.
Revitalizing the Zero-Based Budget
During times of uncertainty, you may need to reallocate resources quickly if circumstances warrant. To do so, companies may intuitively choose a top-down approach because it easily lends itself to centralized decision-making. One benefit is that a top-down approach can help leaders make agile changes in real time without involving multiple departments. But be advised–this method could result in knowledge gaps if departmental stakeholders are excluded.
On the other hand, a clean-sweep, bottom-up approach allows businesses to create flexible cost structures that would enable leaders to funnel expenditures toward the most important business areas. One budgeting method that provides for this type of flexibility is an old one originating in the 1970s – the zero-based budget (ZBB).
Zero-Based Budgets - ZBBs ensure that all expenses are justified for each new period. The process of zero-based budgeting starts from a "zero base," and every function within an organization is continuously analyzed for its needs and costs. A zero base doesn’t necessarily mean a zero sum, but only includes items that can demonstrate a clear return on investment.
When rolled out competently, ZBB has been accredited with building entire cultures of cost management throughout different levels of organizations. Although it may sound counterintuitive, the method is not about directly cutting expenses. It’s about achieving deep visibility. The following are some potential advantages:
- Make Real-Time Adjustments - Your budgets should be formalized and authorized as a general rule. That being said, by implementing a ZBB, you can make strategic adjustments for changing circumstances along the way. It’s been proven time and again that companies that fine-tune their allocation of investments in an agile way tend to perform better and yield higher returns over time.
- Reduce Entitlement - With ZBBs, no expenditure is taken for granted whether for legacy costs or one-offs. And indirectly, ZBBs also tend to reduce the entitlement mentality across organizations.
- Create Scrupulous Managers - The simple truth is that people behave differently when they know their decisions will be routinely scrutinized. Even if upper management is fully on board with mid-level spending, human behavior tends to change when it's made clear that each spending decision will require a review.
Treading Cautiously
Before we go on, it’s important to acknowledge that ZBBs are not for every business all the time. We strongly caution against pursuing a ZBB model for every department. Instead, select several departments and/or agencies, and rotate through them using a phased approach. Rolling out the practice in small increments will likely be the best way to determine whether utilizing a ZBB is suitable for each department. It can feel like a big ask for mid-level managers that requires a significant shift in thinking. That being said, it has proven to help in the strategic resuscitation or culling of hard impacted business lines.
Another main critique of ZBBs is that they reward short-term thinking. But ironically, it’s exactly this real-time agility that may prove critical if the immediate concern is business continuity. Furthermore, ZBBs are known to require meticulous oversight. Fifty years ago, the sheer volume of information needed to calculate ZBBs was too time-consuming a task to justify. Instead, companies used them solely for projects that had fixed costs and/or clear definable results.
But today’s landscape is night and day from the 1970s. Businesses now have access to sophisticated software solutions that provide meaningful insights using robust reporting capabilities. Cloud computing has made collaboration faster and simpler across departments. And instead of spending countless hours fighting unwieldy spreadsheets, leaders can use software to plan at the most granular level in real-time.
Employing Preemptive Tactics
So perhaps you’ve just developed a budget that coordinates business units and tracks performance. But again, enter the black swan (cue music of doom). The thing is, a volatile economy can make your average budget obsolete before it’s even completed. During times of disruption, the path forward will never be a flat, paved road, but there are some additional measures you can take to persevere:
Crafting Contingency Plans
While most businesses are still forecasting annual and quarterly budgets, many are also supplementing these plans with “future alternatives.” In other words, if things go south quickly, you’re going to need a plan B. These additions include supplemental financial statements based on potential future scenarios. Think NASA who always has a back-up plan, to the back-up plan, to the back-up plan. Contingency plans are strategic because they allow you to build flexibility into your cost structures and aptly position you to switch gears should a black swan event occur.
Reviewing Budgets Monthly
As discussed, inflation is the name of the game in 2022. Instead of only analyzing annual and quarterly budgets, you should now make budget adjustments monthly to focus on what’s critical to your success. Recent inflation trends are forcing leaders into making tough calls daily. Businesses are juggling multiple balls, and some may need to bounce. The reality is that a project could potentially experience a budget increase one month and face a cut the next.
Choosing Rolling Forecasts
Rolling forecasts are living documents that allow you to adjust your projections to accommodate change. Instead of committing to a hard and fast annual budget, rolling forecasts allow you to fine-tune the numbers as predictions change. Additional perks include that they tend to be more accurate, facilitate agility, and don’t heavily rely on past results. If you suddenly need to shift course you’re going to be glad you used one.
Tracking Time with Software
Time tracking is essential to budgeting because it gives you the most critical data of all – how work hours were spent. Because for most companies, labor is by far the largest line item. Consider implementing a time tracking policy. The truth is you’re always going to need to track time if you want to invest it wisely. To adapt quicker, respond faster, and deliver better, you need accurate time entry data.
But introducing a time tracking policy is just the first step. Next, invest in a time tracking software solution. While manual spreadsheets are certainly an option, tremendous amounts of data is much more easily managed by software. Cloud-based timesheet software will likely be your best bet. These modern solutions facilitate the planning process and allow for easy collaboration between departments from the initial budgeting stages through the approval process.
Most businesses continuously monitor various types of budgets, such as operating budgets, cash flow budgets, and financial budgets and this takes time to do well. But when you use time tracking software, stakeholders gain easy access to real-time data enabling them to make informed budgeting and planning decisions faster. Leaders not only save time, but they gain the advantage of data accuracy that drives better decision-making. When the day comes that you need to adjust a budget quickly, you’ll need accurate data to support that decision rather than just relying on your intuition.
In addition, the best time tracking software solutions will have vital reporting tools that allow for project budgeting, retainer-based budgeting, and lifetime budgeting. You can use these platforms to allocate employee hours across the projects they work on strategically. This is an important advantage because work hours logged against projects is one of the most critical control parameters in project management.
Focusing on Preparedness
“We are shaping the world faster than we can change ourselves, and we are applying to the present the habits of the past.”
The 21st century has already seen more of its fair share of black swan events: the terrorist attack of 9/11, the 2008 financial crisis, and the coronavirus pandemic to name a few. While it’s always important to budget for growth, carefully take into account your financial assumptions and shifting macroeconomics. One thing we do know is that change is always going to be a constant. And if change is a certainty, then preparedness should be as well.
