Freezing the Budget
The typical budget process ends with the top level approval of the budget. At that point, many organizations choose to "freeze" the budget. Freezing creates a snapshot and generally means locking down the assumptions and results thus establishing a measurement baseline for various dependant purposes. The time period that is frozen depends on the organization.
Summary: Freezing the budget is a decision that sould take into account a number of factors include the quality of the budgeting process and relevance of any assumptions and inputs. More...
Summary: The tactic of freezing budgets is often questioned as to its value. Before that value can analyzed, one must first explore why organizations freeze budgets. They do so for control, performance, compensation, and market guidance reasons. More...
Many organizations may choose to lock or “freeze” the budget results upon completing the final review and sign-off. The decision to freeze the budget depends on many factors, including the role of the budgeting process within the organization, the budget horizon or time interval, level of confidence in the assumptions and process, as well as relevance of the baseline and or inputs.
Some of the benefits of freezing the budget are:
- Establishes a benchmark for the organization’s performance that can be referenced throughout the planning horizon allowing for a clear understanding of what was achieved.
- Ability to track the impacts related to assumptions or inputs that did not occur as expected, and therefore model a revised forecast that is still based on the original plan.
- Removes any subjectivity in evaluating where the organization stands visa-vie the stated objectives at the start of the business cycle.
- If established at the appropriate level in the organization and based on relevant operational drivers, provides a roadmap for achieving success and provides the communication vehicle to lower level management.
- Should be used in conjunction with a forecasting process that allows for more up-to-date inputs to be factored in, but still providing variances to the original budget as a baseline.
On the flip side there are challenges with freezing the budget:
- Does not provide flexibility in guiding the organization should market conditions change or assumptions not hold true.
- Can create more noise in the process and lead to budget bashing or other non-productive activities.
- Leads to multiple versions of the truth when the accompanying forecast tools are not closely controlled and governed.
- Can distract the organization by spending time manipulating offline models to prove the budget should be changed or to justify significant variances.
- As the environment changes, people may be demotivated when the budget becomes either too difficult or too easy to achieve
- Without a solid budgeting process as the starting point, there is no basis for freezing the budget.
- Requires more buy-in from various levels of the organization.
- Encourages local optimization at the expense of the organization's performance.
Many of the challenges to freezing the budget are related to the absence of additional tools (i.e., periodic forecasting or rolling forecasting) that are governed by the same group responsible for the original budget. Ensuring these tools exist and a formal process is in place should be a factor in considering whether freezing the budget is appropriate for the organization.
Finally the complexity of the organization and the environment in which it operates should be considered in determining the appropriateness of freezing the budget. Most organizations operate in an ever-changing environment and with operations that have both controllable and non-controllable factors. A clear understanding of these factors and the influence they have on the organization will not only dictate how relevant the budget can be to begin with, but also how frequently budget assumptions will need to be updated or changed. If the majority of the factors are easy to forecast and will only change within an acceptable tolerance level, the decision to freeze the budget even in the absence of flexible forecasting tools may be acceptable. Undoubtedly this will not be the case for most organizations, so freezing the budget should be done in concert with having a robust forecasting process that allows for version control and provides comparisons to the baseline budget. (as)
The tactic of freezing budgets is often questioned as to its value. Before that value can be analyzed, one must first explore why organizations freeze budgets. They do so for control, performance, compensation, and market guidance reasons.
Control reasons for freezing a budget have operational undertones. Freezing a budget at a given point in time and for a stated period allows an organization to allocate its resources to the areas prioritized within its budget (See Strategy). These priorities may come from demand management or consumption drivers and may also come from cost and capacity drivers. Without budget resource allocation, it can be argued that initiatives, programs, projects, and product/service delivery cannot commence or continue.
Another control purpose for freezing a budget is to institute a cultural incentive or framework to stay within one’s budget. The budget can become a checkbook balance that cannot be overdrawn. The sooner this value is known, the sooner the organizational personnel can make decisions or take actions to fit requirements or demands to the budget. This becomes especially important to organizations that have strict affordability targets in play within the budgeting process. A frozen budget gives that organization its target to hit and thus creates an inherent incentive to take action.
Additionally, a control reason for budget freezing is that it forces statement of work or capacity management prioritization. Looking internally, it means working to translate resource capacity to output capabilities. Externally, it means working on demand requirements and negotiations with customers and suppliers. Both must take into account market and competitive factors. A recommendation is to have a process that encompasses both the internal and external factors. This requires development and maintenance of statement of work and/or capacity driver metrics. To accomplish that, one must understand the Activity Based Cost as well as Activity Based Budget requirements. Please see "The Closed Loop - Implementing Activity-Based Planning and Budgeting".
Budgets are frozen to support performance measurement and provide a baseline. This then leads to analysis and explanation of variances between budget and actuals. Such variances may explain timing differences, or more importantly, may suggest opportunities or risks to the budget. A validated opportunity may allow the organization to spend the money on other priorities, additional sales, or to contribute to profit. A validated risk may require reallocation of budget from another area or risk mitigation.
Compensation becomes a third reason for freezing budgets. Once again, a baseline can be created from which performance can be measured. Those individuals or organizations that have compensation tied to budget performance will know exactly the expectations placed upon them. The budget baseline becomes a yardstick where the individual or organization can then take action to become more efficient, drive toward more profitable or revenue-generating work, or make smarter investments.
Market guidance can be a reason for freezing a budget. External industry and financial investment entities require such guidance for annual and quarterly reports, for example. A frozen budget allows the budgeting organization to analyze market segments, forces, and competitor assumptions placed within its budget targets. Strategic and tactical actions can be deployed to hit those targets.
Quarterly and/or annual guidance can be given to external players such as the financial investment community based on the frozen budget for that time period. Expected performance to budgeted revenues, earnings, and market share are provided. This leads to shareholder valuation as well as an expectation that the company at least meet those numbers.
Freezing a budget can support regulatory and internal requirements while also creating internal incentives and targets. This is not to say that a rolling budget process cannot be fitted with a frozen budget period for the before-mentioned purposes. While rolling forecasts are a topic for another discussion, the use of a frozen budget does not eliminate the use of rolling budgets to more frequently allow for changes and new targets. That frozen budget is used for control, performance, compensation, and market guidance reasons. (ss)
- Because of the muliple uses of a frozen budget, it is imperative that the budget reflects the strategic goals of the organization.
- Have a process that encompasses capacity, capability and demand drivers.
- Be careful what you freeze, you may get freezer burn. Personnel will act according to it which may be counterproductive. Also do not expect a solid result against thawed material.
- Carefully document what measures and time frames from the budget will be frozen and what decisions these will drive. This will provide guidance and boundaries for future uses.
- With a frozen budget, use other forecasting tools to keep visibility to running operations in current environments.
- Source budget information, resource allocations, and key assumptions should be documented and communicated by a central planning function that maintains configuration control.
Your input is welcome here
Your input is welcome here
Issue not derived from implication brainstorming. Rather, it came from subsequent discussion.