Why using inadequate tools and approximating the balance of forecasted Balance Sheet accounts is a bad approach for budgeting
I recently had a discussion with a colleague who is a partner in a local management consulting firm about organizations’ attitude toward the planning and budgeting process and the benefits they reap from these activities. I expressed my views on how a proper budget should be prepared and why it is vital to budget the entire chart of accounts with the benefit of obtaining a complete set of future period financial statements. I further explained that all accounts that contribute to creating the Balance Sheet must have their balances updated throughout the budget period, performed through increases and decreases (debit and credits) which are derived from the forecast of revenue and expense accounts (Income Statement accounts).
The argument against doing this was (according to this person) that you can use a spreadsheet to forecast the ending balances of all critical Balance Sheet accounts using simple assumptions and the data from forecasted revenue and expense accounts. He recognized that this would be a rough approximation of account balances but argued that since most budgets are not accurate anyway and companies almost never hit their revenue and expense targets, even if there was a way to accurately and completely forecast the Balance Sheet and Statement of Cash Flows, they would be inaccurate due to the inaccuracy of the revenue and expense account balances all due to bad assumptions, inaccurate budget data supplied by the various reporting entities and other reasons.
The reason I bring up this subject is that I have heard these arguments before from finance executives and professionals who were tasked with preparing their companies’ annual budgets but not given the appropriate tools to do so, added to old traditions, misconceptions and workloads only allowing these people to repeat traditional processes without taking the initiative to look for more advanced ways to obtain meaningful and useful results.
If you accept the fact that budgets are never accurate and therefore no additional effort should be put into forecasting what really matters (e.g., cash account balances, other assets and liability account balances, etc.) than you are left with repeating the same budget process chores year after year with little or no benefit to the company. With this attitude, how can we expect company managements to make solid business decisions, let alone have insight into the future financial health of their organizations?
It is true that advanced software solutions such as Budget Maestro by Centage Corporation can produce inaccurate budget period Balance Sheets as compared with the actual accounting Balance Sheets. Of course, the forecasted P&L will also be different than the actual period P&L. But these forecasted Balance Sheets and Statements of Cash Flows are always going to be accurate and true to their corresponding forecasted Income Statements through the built-in logic and automated journal entries that ensure that each Balance Sheet account’s balance is correct.
If you are approximating or grossly estimating the balances of your forecasted Balance Sheet accounts through use of spreadsheets or purpose designed Planning and Budgeting software solutions that behave like spreadsheets (e.g., require user supplied formals and links and with no built-in business logic and automated journal entries) your errors are likely to be compounded by the errors in the forecast of revenue and expenses. Essentially, what you get is an inaccurate P&L forecast driving a flawed Balance Sheet forecast causing its account balances to be removed from reality; that is if the Balance Sheet is forecasted at all.
In contrast, if you use a solution that ensures your forecasted Balance Sheet and Statement of Cash Flows are systematically complete and accurate by the nature of the system logic and automated forecasted transaction processing, you can focus on good planning and budgeting with built-in tools and business logic that will allow your P&L forecast to be complete and reasonably accurate; as accurate as your assumptions. The accuracy and completeness of your forecasted Balance Sheet and Statement of Cash Flows will follow and match the accuracy of the Income Statement.
That is a giant leap from traditional budgeting approaches, those based on tradition, bad habits and inferior tools. I think it is time to evaluate the new alternatives.