3 Pitfalls of Static Planning (And the Solutions)

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Monday, May 17, 2021

While static planning has its merits, businesses seeking to become resilient and adaptable need a more dynamic approach to budget planning.

Article 5 Minutes
3 Pitfalls of Static Planning (And the Solutions)

Budgets are crucial to enable organizations to track their financial performance, analyze outgoings and identify possible areas to maximize profits. There are, of course, different ways of planning a budget, which can roughly be separated into two categories: static planning and dynamic planning.

There are both advantages and disadvantages to each of these approaches. However, in an age where agility and flexibility are essential to business resilience and success, dynamic planning allows for more adaptability and may well be the better choice for most organizations.

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In this article, we’ll discuss the disadvantages that come with static financial planning, and how companies can begin to solve those problems and move towards a more dynamic form of budgeting.

Static financial planning

In an article about static planning, The Motley Fool describes how static budgets work, with an example:

A static budget is based on a company's anticipated level of output and revenue at the start of the accounting period it's designated to cover. Static budgets are typically based on data that is collected and analyzed before the budget period begins. For example, if a company brought in $2 million in revenue last year, it might create a static budget based on the same revenue figure.
 

Once a business establishes a static budget, it will then follow it and measure against its actual spending throughout the year, paying close attention to any variances. If revenue incoming is higher than the budget planning for, this is of course a favourable variance. If it’s less, then it isn’t.

Disadvantages of static financial planning

Lack of flexibility

The chief drawback when it comes to static planning is the lack of flexibility it offers. A fixed budget drawn up based on assumptions made at the start of the fiscal year precludes the ability for an organization to react when circumstances change. In today’s market conditions, when change seems to be the only constant, that could end up being catastrophic for many businesses.

As per Wall Street Mojo:

If an organization plans a budget on a certain level of sales and conditions and the level of sales increases/decreases due to any reason, the static budget cannot allocate the additional sales and its cost incurred in the existing budget.
 

Inability to react

Stemming from the lack of flexibility, with static planning, a company can’t react to volatility by increasing or decreasing funds in areas where it finds under-performance. This inability to react and make better utilization of funds can negatively impact an organization’s revenue stream.

There’s also an additional drawback for newer companies: static planning is based on performance data from previous quarters or fiscal years. Companies that are just starting out naturally won’t have this data to base their planning on.

Narrow application

This type of budget can be highly useful for organizations with highly predictable sales and expenses. By contrast, though, this means that businesses that experience volatile revenue flows can’t rely on static planning to see them through spikes or falls in demand or supply. As we’ve seen since early 2020, businesses can take nothing for granted when it comes to economic uncertainty, and with that set to continue throughout 2021, the dangers of static planning are perhaps more acute than ever.

Dynamic financial planning

So how can you move from static financial planning to dynamic planning?

There are a number of steps organizations can take to become more dynamic in their financial planning. First of all, look to democratize the data. Technology can facilitate this, making it possible to give people tools that allow them to access relevant data when they need it. It also lets employees know they’re valued, and is more likely to achieve enthusiastic buy-in for a dynamic planning strategy.

Next, look to bring financial data into day to day operations. Financial data is sometimes the sole preserve of the financial department itself, which is probably a hangover from the days when such information was difficult to collect and disseminate. Thanks to superior data collection and analysis tools those days are over, and given that financial data impacts every department within a business, it doesn’t make sense to keep it siloed away in the accounting team.

Dynamic planning, therefore, should look to flow this information into other teams so that it can be used to inform decision making in daily operations. To support this, the finance team should aim to foster greater collaboration, moving from the back room to the main arena of operations, where they can better assist various departments to build a picture of how they themselves are performing against budget. This will allow for quicker reactive moves or even more proactive operations when things aren’t going to plan.

Having a stronger, more tangible grasp of what’s happening in practice, informed by up-to-date financial metrics, makes it easier for teams to spot trends in the market early, or identify ahead of time the general direction of business performance.

Once financial data is embedded within the general operational approach, it can begin to be brought into the strategy level of the business. Dynamic planning can make use of financial data as and when it changes, enabling a more agile way to guide the direction of the business, taking advantage of the prevailing winds of the market.

With the continuing uncertainty wrought by COVID-19 unlikely to disappear any time soon, and economic and social upheaval sure to follow, there’s never been more urgency around the need for businesses to be agile. A move away from static financial planning to an approach that values versatility, then, is integral to success going forward. As the saying goes, ‘failing to prepare is preparing to fail’. Right now, failing to prepare continuously is what organizations need to avoid.

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