Innovations require you tochange directions with both yourproduct and strategy as newinformation comes to light. Abudget process needs to supportthis agility, it should roll withyou, help you learn faster andtrigger creative behavior.The AgileBudget
Budgeting is a big part of an organization,it consumes a large amount of peoples timeand sets constraints on plans and projects.It can, in worst case, determine what theorganization should do a year and a half inadvance. The budget process can also addto command and control behavior,strangling innovation.Budgeting may not be the only thing holding you back, but it cancertainly be a major issue. Personally, I want to know if money isbeing used wisely, if we spend it on things that matter for us, notonly right now but also in the long run. I want to know that we aremaking more money than we spend. I want to know what theforecast is looking like. I want to know if we should regroup ourforces in some other direction to react to opportunities or threats.What I don‟t want is to be controlled by an estimate that does notmake sense anymore. I don‟t want a business case that is basedon early assumptions long past their expiration date, that havebecome false realities my project revolves around. I don‟t want tospend endless of hours gathering data, re-estimating, debatingwhy I should get more funding to keep my current commitment onannual basis. I don‟t want performance targets that aim to keepmy budget.I‟m pretty clear on what I want and what I don‟t want and I‟m notthe only one. That said most companies budget process is morelike what I don‟t want. They often stand in the way of agility anddoing what is right to do. They are designed with good intentionsbut often have counterintuitive side effects, resulting in usspending more money instead of using wisely.The annual budget process has some nasty side effects that arehard to see because it all seams to be logical at first sight. It alsohas a long legacy in the traditional way things are done.The biggest of all fallacies is that you can predict how muchinnovative projects will cost a year in advance. Most projects arelate and over budget because of unknowable factors that makepredictions obsolete.A second fallacy is that a budget stops you from spending moremoney than you can afford. I sometimes wish I was bugged with asecret microphone linked to the CFO when I hear people say “Wehave to spend our budget in order to get the same amount nextyear”. Consider what behavior this triggers, and if it encouragesmoney to be used wisely.Another problem is that the budget is claimed as someonesproperty, usually a manager, to do with what he or she believes isbest. This encourages command and control behavior from thatmanager, since they are responsible to keep within the budget,and, in worst case, are rewarded if successful.The budget process can be an enabler of agility and innovation, orit can be an obstacle people have to overcome. I prefer a moreinnovative budget process and this article aims to provide someguidelines for developing this.[wikipedia.org]“No complaint … is more common thanthat of a scarcity of money.”Adam Smith, “TheWealth of nations”
Income statementA product or a product line should somehowcontribute to an organizations profit. Whether itcontributes directly or strategically should beknown. An Income Statement, also known asProfit & Loss statement, is a good way to come togrips with these questions.An income statement is not very different from your householdbudget. In fact many homes could benefit from using thistechnique to keep from entering the luxury trap. I wish my parentshad used it when we were kids, we would have had a lot morerespect for where money come and went.The income statement consists of two parts, income andexpenses. It tracks products or business performance over aperiod of time. It‟s a periodic statement that can illustrate trends across-functional team would be very interested in. Even if I havenever heard anyone address it directly, the idea that “Money that’ssomeone else’s concern”, is an attitude I‟ve observed frequently.Maybe this is because so few have insight into the moneyprocess. Often all that‟s communicated is the CEO quarterlynumbers. These are both uninspiring and mean little to theaverage Joe. However money is a shared resource and should betreated as such, it‟s everyones business as it directly effects howwe spend our time.The income statement usually has the same components. Itshows the Total Revenue (number of units x price). The costrequired to produce the product known as COGS and thedifference or Gross profit. It shows Expenses such as R&D,sales, etc. Some use Earnings before Interest and Taxes,Depreciation and Amortization (EBITDA). The most important partis the Net Income which tells you if you are making money or not.The income statement can be used together with a rolling budgetwith a time window looking back a short period, and forward alonger period. It is more important to look forward in order to planand facilitate direction changes when needed, than focusing onanalyzing the past. Questions remain weather we invest harder infuture innovations, or focus on sales and marketing to boost shortterm revenue? These are the responsibility of the cross-functionalteam.Imagine that there is an annual budget and it is fixed. A fixedamount of money is allocated to each different part of theorganization. Imagine that sales of a new product line are not takingoff. The income statement shows the loss of the first three moths.What are you going to do? Stick to the plan and begin the nextprojects, or do you shift focus to find out why sales haven‟tperformed as planned? Did you develop something that no-onewanted. Did you spend to too much money before testing yourassumptions? Did the sales force have to cut prices in half in orderto meet their sales targets and keep their bonus.The income statement is a great method for getting everyoneinvolved and to alert you to changes from forecast. It can be usedto track trends and work to relatively reduce cost and increaserevenue. It is a periodic, rolling and iterative tool supporting youragility and ability to create value.[garyhamel.com]“Most companies are run byexecutives who know everythingabout cost and next to nothingabout value.”Gary Hamel, “What mattersnow”
Business Case LearningHave you ever had an idea for an innovation andgone running to your manager to present theidea only to be given a business case template.“Please fill this in and come back”. Did you looseor gain motivation?You should be more motivated. If I was the one who approvednew projects I would definitely want people to understand thereasons behind their business case and to clarify and understandthe assumptions of the new idea. When I went to businessschool I was taught that a business case should show the value ofa new idea and be used to determine if you should go further withit or not. Generally this is how it gets used however I think this isthe wrong approach. The value of the business case is notdetermined by the expected outcome, return on investment, netpresent value, or bang for the buck, It rests on the assumptionsmade. You assume that you will sell this or that amount ofproducts, you assume that it will take this or that much time andresources. Based on what data? Early and rough estimates. Themore innovative the product the more uncertain the estimates. Notthat the revenue is unimportant, it‟s just not the most importantpart. If I were to create a business case manifesto, this would besomething I highlight.Verifying assumptions early through rapidprototyping over detailed financial business cases.Don‟t get me wrong, I see the benefit in using business cases anduse them frequently, but I also see them being used incorrectly,blocking innovation and creative thinking. You can get stuck intime-and-cost-only mode. Below I outline some ideas I have ondifferent financial tools for calculating value.Net Present ValueThis tool is good for understanding on which assumptions the newproduct idea is based. Focus should be on listing the assumptionsand outlining actions for testing them, not the actual NPV and IRRnumbers. These only become interesting when the assumptionshave been verified and early risks are eliminated. It should not beused in early decision making and is not really a good tool for agileprojects.Bang for the Buck IndexThis tool has the same weakness as NPV, but adds the time criticalfactor which might help when time is short and cash flow is focus. Itpromotes maximizing value in the shortest time. But what aboutlong term innovations? They are probably not a problem anymore,there won‟t be any if this tool is used for decision making.Return On InvestmentThis is my choice when I can choose. It is the easiest tool to use,focusing on the relationship between revenue and cost. It stillrequires you to understand the assumptions you make but it canalso be combined with income statements as forecasts for newproducts, listed as separate statements for each product.[claytonchristensen.com]“These are not bad [financial] toolsand concepts, we hasten to add. Butthe way they are commonly wieldedin evaluating investments creates asystematic bias against innovation.”Clayton Christensen, “HBRarticle: Innovation Killers”
Portfolio ManagementThe Portfolio Management function should help youunderstand how to collectively move forward withyour products, aligning them strategically. Itfacilitates decision-making on projects, people andmoney allocation. Note that it should help you notrestrict you. Moving forward is about exploring asfast as possible, anticipating and adapting whenneeded. Allocating money should be about the samethings.Classical Portfolio Management theory is about maximizing thevalue of the portfolio of projects, with the goal that you spendmoney on the investments that bring you the greatest return. If thiswas the only approach it would be quite restrictive, focusing onlyon anticipation.The financial methods used in Portfolio Management are financialinvestment and allocation methods. The different allocationmethods are more or less adaptive. Developing an innovativeproduct is mostly about exploring and adapting until you havereached the mass market and have a strong product penetration.However anticipation handles only incremental growth withrelatively low risk. Innovation needs a different approach.Strategic BucketsOne common method is Strategic Buckets. Here different budgetsare separated into different “buckets” and handed over toindividual responsible units to spend on investments. Each unithandles its own bucket. Usually planned annually (We know theproblem with this approach).Target levelsAnother more flexible method is Target Levels. The difference fromStrategic Buckets is that the money is in one bucket only and thattargets are only targets, not fixed budgets. It gives you muchgreater freedom to move money after opportunities.Emergent budgetThe most flexible approach would be to have investments emergebottom-up, from the front line in the organization. That is reacting tomarket opportunities, not trying to control it top down.Top-down, bottom-upA combination of Target levels and an Emergent approach can be agood thing whether you are in the middle of a transformation oryou‟re a big mature company. This approach qualifies on all threeparameters; exploration, adaptation, and anticipation.The key characteristics of the Portfolio Management function are;Easy to move money as new information and opportunities emerge,Not planned in a too far advance (monthly rather than yearly), Afocus on strategic investments rather than uncertain financial value.[jurgenappelo.com]“Apart from looking forward(proactive), and lookingbackward (reactive), don’t forgetto try things out (safe-to-failexperiments).”Jurgen Appelo,“Management 3.0” onComplexity Thinking
Beyond BudgetingInnovation is today perhaps the only way to stay inbusiness. Constantly seeking new products and newbusiness models is necessary. By followingtraditional plan-driven models you may wind upwith a product that’s obsolete before it’s evenlaunched. A complete management model mustseed and support internal startup innovation as theonly sustainable option.If the words „Beyond Budgeting‟ suggests that we don‟t managebudgets any more, this is not the case, it simply means that theyare managed differently. It means that we move beyond thecommand and control methods that the annual budget cyclepromotes.The Beyond Budgeting model has 12 principles . These are moremanagement principles that actual budget tools. As with any toolthey need healthy management to work properly. If you followthese principles I think that the question of how to manage thebudget is no longer such a problem. Check them out, they speakfor them selves.Govern through a few clear values, goals, and boundaries,not detailed rules and budgets.Create a high performance climate based on relative success,not on meeting fixed targets.Promote open information for self management, don‟t restrict itwith hierarchy.Organize as a network of self-organizing lean, accountableteams, not around centralized functions.Give teams the freedom and capability to act, don‟t micromanage them.Focus everyone on improving customer outcome, not onhierarchy relationships.Set relative goals for continuous improvements, don‟t negotiatefixed performance contracts.Make planning a continuous and inclusive process, not a top-down annual event.Coordinate interactions dynamically, not through annualplanning cycles.Make resources available as needed, not through annual budgetallocations.Base controls on relative indicators and trends, not on varianceagainst plan.[theleanstartup.com]“Startups often accidentally buildsomething nobody wants, it doesn’tmatter much they do it on time andon budget. The goal of a startup is tofigure out the right thing to build asfast as possible.”Eric Ries, “The Lean Startup”
The Rolling BudgetWhere is the best way to look if you want toknow where you are going, backward or forward?This question has multiple answers, we need toknow where we have been, but of course we haveto look forward. I guess the right answer is both,but we also need to look at where we are rightnow.The rolling budget follows a different cycle than annual budgeting.The annual budget usually has a cycle which follows the fiscalyear. The rolling budget doesnt follow the fiscal year, but uses atime window looking forward for a period that makes-sense to you,perhaps 5 months for small fast moving companies, perhaps 18months for large industrials. That said the rolling budget isupdated as soon as you have learnt something new.Annual budgeting reports on variance against plan while rollingbudgeting reports on trends. Where traditional budgets strugglewith time, cost and expanded budget requests for projectoverruns, beyond budgeting focuses on the best way forward andpromotes creative solutions to meet ambitious targets. Look at thetwo charts, which one gives you the most information?Annual reporting shows a target budget (agreed budget), themonthly spend up until year-to-date, and a total forecast which isthe overrun. What will be your focus? How much time and moneyis needed to complete the projects, right? Is that the right focus? Shouldn‟t the focus be: What have we learned? What should wechange to develop something that the customer really wants, and iswilling to pay for? The rolling forecast helps focus on the future andthose actions needed to adapt to new information.[axiomgroup.com]“The forecast shall revel issueson the radar screen earlyenough for us to take thenecessary actions.”Bjarte Bogsnes, “ImplementingBeyond Budgeting”0500000100000015000002000000250000030000003500000400000045000005000000Target BudgetForecastYTDAnnual reporting050000100000150000200000250000300000350000400000450000Feb Mar Apr Maj Jun Jul Aug Sep Okt Nov Dec Jan Feb Mar Apr MajTargetMonth actualForecast development12 month avg actualRolling reporting
Transvisual SpendingAre you scared that costs will get out of control ifpeople can just do what they want when it is “theright thing to do”? I’m more scared of the traditionalsituation where only a few people have the insightinto how much money there is and they lack theknowledge of exactly how it’s spent.This is actually the case in most companies I‟ve worked for and inothers I know of. Not unusually the line manager has the budgetfor the department and the project managers have their budget foreach project. People spend money every day, every hour. Theonly way for the managers to keep track is to control all expensesand activities. And that‟s where the creativity goes out of thewindow. Creativity needs a fundamental prerequisite, “space tomove”. People have to be able to spend time and money withoutasking permission before they do it. You can‟t know everything inadvance especially when you are not sure what you are about todo next.That said, we need to manage this shared and limited resource.Believe it or not, there is never an endless supply of money, evenif you work for one of the biggest companies. This is whereTransvisual Spending comes in. When there are too many costdrivers and too few people who know about them, this is asituation that needs to change. Everyone has to know about thespending and care about it.Transvisual Spending is an abbreviation of transparent visualspending. Transparent so that everyone can see who has spentmoney, when, on what and why. Usually you just get a report thatmoney has been spent, from an unknown source and for anunknown purpose.Visual in that it is more than just numbers on a wall, it needs tohave a physical form in order to trigger your right brain, like abucket of gold wrapped chocolate coinsBy having a physical representation and transparency everyone isaware of what is going on.“Oh my, the money is almost gone. Why did you spend it on thatstupid thing when we need this instead.”This initiates positive peer-pressure, helping everyone to micromanage each other in a way better than any manager could do.There is huge difference in mindset this triggers a completelydifferent behavior. As Bjarte Bogsnes puts it. ‟The traditionalquestion is “Do we have budget for this?”, where the question reallyshould be “Is this really the right thing to do?” „. Transparency andthe resulting peer supervision encourages people to ask the rightquestion.What do you think will happen to costs when spending is open andtransparent, combined with attitudes of responsibility andaccountability, when each action is judged by peers and the budgetis visually accessible every single day. Will it go up or down?[jurgenappelo.com]“Management is too importantto left to managers”JurgenAppelo, “Management 3.0”
The Agile BudgetingTo manage uncertainty is to manage yourpresent, near future and visionary goals. We needto be able to make quick changes indirection, verify that we are on the righttrack, and continue to explore our way into thefuture.The Agile Budget model is composed of different models eachfitting into an iterative development cycle that supports agility.Some of the models have already been described breifly. It is timeto put them together.Each agile cross-functional team is usually part of a bigger cross-functional team, call it the product team. It consists of all thepeople needed to produce the product;R&D, Marketing, sales, logistics, IT, etc. They form an internalecosystem, a viable system responsible for their product. Theymight be part of an even bigger system, but lets ignore that for themoment. To be viable is to be self sustaining. In money terms itmeans you are on top of your finances and contribute to the wholeorganization, i.e. you make a profit.Use the rolling budget cycle and map it to your iteration, andrelease cycles. For example two week sprints means updating theforecasts on a two week basis. Use a rolling window with a forecasthorizon of 3-5 x release length. If you release every secondmonth, that window would be 6-10 months. It should fit in with yourstrategic milestones and vision time line as well. Calculate theaverage sprint cost to use as a reference point. Make sure youupdate the forecast with future reoccurring costs likelicense, hardware, etc. The example below has a 1 week iterationperiod and monthly releases.AgileteamsProductteam050000100000150000200000250000300000350000400000450000TargetMonth actualForecast development12 month avgUse the Income Statement to manage profit and loss and map itto release cycles. Add separate accounts for new projectbusiness cases and calculate expected forecasts of Return OnInvestment. This fits well with forecast periods and your agileestimation techniques, provides pretty detailed and reasonablygood estimates for the next release period and rougher estimatesfor a couple of releases away.
The example (left) is an Income Statement for an iPhone app. They fill inactual, forecast and target for each release (period). They have synchronizedthe release cycles with each calendar month for simplicity. As you can see theyneed some drastic changes to increase Net income. Let’s hope that the otherprojects will deliver expected ROI. I use a Cash Flow Statement to show theactual money available. This is easy to map to the release periods. In this casethe product team is low on cash and need to borrow from the corporate budgetfor release A and B, until they start a positive trend.The budget is emergent and updated on a regular basis. You don‟thave to ask for budget permission, you already know the answerfrom the Cash Flow Statement. The cash flow can easily bemanaged with, as suggested, a physical bucket with say candyrepresenting the cash. Every time someone spends money onthings other than “normal” expenses like salary, office rentetc, they take some candy coins. After each iteration when theproduct is generating some profit you fill the bucket up againaccording to actual. Lego or other playful items can symbolize thesame thing, figure out something that is visual and fun for you.Release A (Jan) Release B (Feb) Release C (Mar) Release D (Apr)Sales iPhone AppsActual 400Forecast 420 600 1000 1200Target / period 500 800 1500 2000Price per unit $2,00 $2,00 $2,00 $2,00Total Revenue Actual $800,00Total Revenue Forecast $840,00 $1 200,00 $2 000,00 $2 400,00Total Revenue Target $1 000,00 $1 600,00 $3 000,00 $4 000,00Diff Actual / Target 80%Cost of goods sold (COGS)Total Material & LaborActual $100,00Total Material & LaborForecast $80,00 $80,00 $80,00 $80,00Total Material & LaborTarget $50,00 $50,00 $50,00 $50,00Gross profit actual $700,00Gross profit (%) 88%Gross profit Forecast $760,00 $1 120,00 $1 920,00 $2 320,00Gross profit (%) 90% 93% 96% 97%Gross profit Target $950,00 $1 550,00 $2 950,00 $3 950,00Gross profit (%) 95% 97% 98% 99%ExpensesMarketing Actual $80,00Marketing Forecast $120,00 $120,00 $120,00 $120,00Marketing Target $100,00 $100,00 $100,00 $100,00R&D Actual $3 000,00R&D Forecast $3 200,00 $4 000,00 $4 000,00 $4 000,00R&D Target $3 500,00 $3 500,00 $3 500,00 $3 500,00Admin Actual $40,00Admin Forecast $20,00 $20,00 $20,00 $20,00Admin Target $15,00 $15,00 $15,00 $15,00Total expenses Actual $3 120,00Total expenses Forecast $3 340,00 $4 140,00 $4 140,00 $4 140,00Total expenses Target $3 615,00 $3 615,00 $3 615,00 $3 615,00Net income Actual (profit) $-2 420,00Net income Actual (%) -303%Net income Forecast (profit) $-2 580,00 $-3 020,00 $-2 220,00 $-1 820,00Net income Forecast (%) -307% -252% -111% -76%Net income Target (profit) $-2 665,00 $-2 065,00 $-665,00 $335,00Net income Target(%) -267% -129% -22% 8%Income statementRelease A (Jan) Release B (Feb) Release C (Mar) Release D (Apr)New projectsProject ATotal Revenue $1 000,00 $2 000,00 $4 000,00 $8 000,00Total Expenses $3 000,00 $3 000,00 $3 000,00 $3 000,00ROI -67% -33% 33% 167%Release A (Jan) Release B (Feb) Release C (Mar) Release D (Apr)Cash flow from operationsGross profit Actual/Forecast, newproject return $1 700,00 $3 120,00 $5 920,00 $10 320,00Cash flow from financingLoan incoming, repaymanet, andtaxes $4 420,00 $1 000,00 $- $-Cash flow from investmentsTotal expenses actual, new projectinvestment $-6 120,00 $-3 000,00 $-3 000,00 $-3 000,00Net Cash Flow $- $1 120,00 $2 920,00 $7 320,00Investment and Cash Flow Statement
Adding budgeting to your agile process is simple and valuable.The periodic process is already there, it‟s just a matter of addingthe actions needed to manage the finances. There are some newartifacts and processes that are required.For example, in the release planning process, financial forecastssuch as expected revenue for existing and new products, shouldbe added. These can be called Financial Spikes that you estimateand include in order to gain more knowledge. The DoD (Definitionof Done) for these have only one initial bullet, that is to update theIncome Statement.If the Financial Spike needs to be broken down into different partsthey can be called Financial Stories. These can be differentdepending on what is required. For example: Meet with sales forceto understand market needs, help key account sales with pre-sales of a newly launched product to boost short term sales, orreplace a costly license with open source to cut fixed costs.At the end of each release, the Income Statement is updated andthe figures are reviewed by the whole team at a retrospectivemeeting. Suggestions for making the financial balance better aregathered and added to the backlog. The Financial Improvementsare planned for each iteration. The different activities can bemapped into the Agile Product Management Framework as shownon the next page. See Investment Review, Budget Review, andSpending ReviewAgile teams are self-organizing, empowered, self-developing andself-directed right? Trust is a core value. What do you have to doto gain trust? Would you trust someone who does not have thefinance under control? My answer would be no, I guess that eachcompany have to figure out how to transform their financialgovernance to Finance as a Service.Financial SpikesFinancial StoriesRetrospectivemeetingPlanningmeeting
Johan Oskarsson@johanoskarssonwww.captaintrouble.com Inspirational sourcesManagement 3.0 – Jurgen AppeloThe Product Manager‟s desk reference – Steven HainesImplementing Beyond Budgeting – Bjarte BogsnesBeyond Budgeting – Jeremy Hope, Robin FraserThe Lean startup – Eric RiesThe four steps to the epiphany – Steven Gary BlankThanks to David Jackson for editing and theoretical dialogues.