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Three Benefits of Driver-Based Budgeting

insightsoftware -
November 8, 2021

insightsoftware is a global provider of reporting, analytics, and performance management solutions, empowering organizations to unlock business data and transform the way finance and data teams operate.

Writing notes.

Driver-based budgeting (DBB) is a planning and budgeting process that focuses on the key variables that most dramatically impact business performance and ties budget numbers to the physical resources necessary to achieve targets for each of those variables. DBB can be a bit tricky to understand, largely because it begins from a fundamentally different premise than most other budgeting approaches.

For that reason, it is best explained by offering examples of how it differs from traditional budgeting processes. This article explores some basic definitions of DBB with examples and then zeros in on some of the key benefits of DBB.

Identifying Key Business Drivers

The DBB process begins with identifying the variables that have the greatest impact on overall business performance. Those may include internal factors such as the total number of customers or subscribers, number of salespeople or distributors, or average revenue per customer. They might also include external factors such as total market size, commodity prices, or even weather conditions. DBB builds a budget based on key business objectives, baseline assumptions about external drivers, and a results-driven approach to internal business drivers.

If any of those input variables change, you can adjust the budget to suit new conditions. Consider, for example, a ski resort business in which early-season and late-season business are especially dependent on weather conditions. An early onset of cold weather, especially if there’s an unseasonably large amount of snow early in the season, will undoubtedly affect revenue, as skiers flock to the slopes after a long off-season. That, in turn, impacts personnel requirements; not only for ski area operations, but also for lodging, restaurants, and other ancillary businesses that benefit from the good weather conditions.

DBB begins with those key business drivers (in this case, weather being a primary driver) and builds a budget based on that. If weather conditions turn out to be unfavorable, you can automatically adjust numbers throughout the budget to suit the situation. This results in a highly responsive budget that directly connects revenue and expenses to external drivers and the physical resources required to deliver the company’s products and services at expected levels.

DBB may also incorporate internal drivers, that is, factors over which the company has considerably greater control. Consider a company that depends heavily (as many do) on the activities of its direct salesforce. Sales effectiveness hinges on the team’s ability to generate appointments to keep the sales funnel full. That, in turn, is highly dependent on the number of outbound calls and list quality, among other things.

Reading Documents

DBB starts with the premise that those sales-generating activities consume a certain amount of resources, primarily including staff time. Based on past history, you can predict the percentage of calls that will result in appointments, and the percentage of sales appointments that will ultimately result in closed deals. Budgeting for the people, lists, and equipment to make that happen is a function of applying those percentages to a target revenue number in order to arrive at a list of associated costs. If the organization wants to ramp up sales, the budget numbers are driven upward based on what you will require to meet that new target. Likewise, if there’s a reason to ramp the numbers down (such as a sharp decline in market conditions), then the budget numbers move downward accordingly based on actual resource requirements.

Once you understand the basics of this approach, it’s easy to see some of the key DBB benefits.

Benefit #1. Identifies the Business Drivers that Matter Most

First and foremost, DBB compels business leaders to identify the factors that have the greatest impact on revenue and expenses. To be successful, DBB must remain relatively simple; driver-based planning models cannot be excessively complex. If they are, the entire DBB process can get bogged down in cumbersome details that don’t add sufficient value to the overall approach.

Looking At A Computer Screen

Instead, management should focus on between three and seven factors that have the greatest impact on budget. In most cases, those will comprise a mix of both internal and external factors, variables that are within the control of management and some that fall outside of the company’s control. Companies that implement DBB must initially engage in some introspection to identify these key business drivers, but when they do, it provides management with key insights as to their primary levers of control, as well as the important factors that fall outside of it.

Benefit #2. Ties Business Accountability to Budget Allocations

DBB also creates a direct line of accountability between budget allocations and actual business results. DBB is based on the premise that certain activities produce certain results, and that those activities, in turn, require a relatively predictable level of resource allocation.

When commonly understood estimates that are built upon reasonable, mutually agreed business rules drive your budget, it becomes relatively easy to assess performance against established targets. Just as importantly, DBB builds flexibility into budgeting and planning processes, such that you can adjust resource allocation and performance targets up or down as appropriate. Although the resulting budget numbers may change, the underlying business rules do not.

Benefit #3. Reduces Budget Negotiation and Gaming the System

For the same reason, DBB reduces the extent to which department heads must negotiate for budget dollars. With DBB, negotiation must generally operate at the level of determining business rules. To return to the previous example around direct sales, there must be some agreement as to how large the sales funnel must be, what percentage of sales appointments typically result in closed deals, average revenue per deal, and so on. But the temptation to demand “doing more with less” decreases. Unless something in the sales process fundamentally changes to increase efficiency or close rates, the company should have a fairly clear idea as to what is realistic based on past history.

Likewise, the temptation to pad budgets with additional spending or to engage in “sandbagging” also decreases. A mutually agreed set of rules for each key business driver dictates the budget allocations.

DBB is an innovative approach that offers some distinct advantages over traditional planning and budgeting approaches, but its success hinges on having the right technology tools in place to do the job effectively. If your organization is interested in exploring DBB, download our free ebook, Driver-Based Budgeting and Planning: A Guide for Finance Teams.

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