What is the underlying requirement here? Is it so you can calculate the number of business days expired so far, or that exist in a given month? If that is the object there are probably better ways to go about it that messing about with the numbers in this way.

The requirement is they want each day that is a working in the month numbered so when they compare to the previous month, etc, they know the work days they are comparing. The weekends should display the same number as the Friday before. I cannot change their requirement

Actually it might be easier than that; if you have an attribute weekend_or_holiday against each date can you not do a COUNT against that attribute to determine the effective workday number?

Something like I've shown below (though I haven't had a chance to test it).

Alternatively if you're able to get another column in your table that will flag a positive '1' against each row that is a workday, you could just SUM for the workdaynum whether it's a weekday or not.

select
thedate,
weekend_or_holiday,
workdaynum= CASE weekend_or_holiday
	WHEN 1 THEN (SELECT COUNT(td.weekend_or_holiday) FROM tbldates tbldb WHERE tbldb.thedate<tblda.thedate AND DATEPART(m,tbldb.thedate)=DATEPART(m,tblda.thedate)) AND weekend_or_holiday=0
 ELSE row_number() over (
            partition by datediff(m,0,thedate), weekend_or_holiday
            order by thedate) end
from tbldates tblda
order by thedate    

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Sorry, I misplaced a bracket in that last piece of code...

select
thedate,
weekend_or_holiday,
workdaynum= CASE weekend_or_holiday
	WHEN 1 THEN 
	(SELECT 
		COUNT(td.weekend_or_holiday) 
		FROM tbldates tbldb 
		WHERE tbldb.thedate<tblda.thedate 
			AND DATEPART(m,tbldb.thedate)=DATEPART(m,tblda.thedate) AND weekend_or_holiday=0)
 ELSE row_number() over (
            partition by datediff(m,0,thedate), weekend_or_holiday
            order by thedate) end
from tbldates tblda
order by thedate     

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The suggestions don't seem to work when there are two holiday days in a row, such as Thanksgiving when the holidays are Thursday and Friday. It should load the work day number for Wednesday for both Thursday and Friday and it does not.  the case statement works well for weekends however.

> The suggestions don't seem to work

You mean http:#a34086622 inclusive? That would be strange..

I'm working on to make sure I am doing it right.

Ok, I have it working. The only part that I needed to get working was populating the Weekends and holidays with the correct working day number. I used pieces of the suggestions above to come up with the following:

1) This part was working anyway

;WITH tmp as(select
CALENDAR_DATE,
WORK_DAY_NUMBER,
setto=case
      when IS_WEEKEND='X' or IS_HOLIDAY = 'X' then 0
      else row_number() over (
            partition by datediff(m,0,CALENDAR_DATE),IS_WEEKEND_HOLIDAY
            order by CALENDAR_DATE) end
from dbo.TIME_DIM
)
update tmp set WORK_DAY_NUMBER = setto

2) This section uses some of your suggestions above to populate the Working Day number for the Weekends and Holidays
--update Holidays and Weekends with preceding workday number
;with holiday_weekends as(select
a.CALENDAR_DATE,
a.WORK_DAY_NUMBER,
setto=case when WORK_DAY_NUMBER = 0 then (select max(b.WORK_DAY_NUMBER) from dbo.TIME_DIM b
where b.CALENDAR_DATE >=
convert(datetime,convert(varchar(10),Dateadd(mm,-0,a.CALENDAR_DATE)-Day(Dateadd(mm,-0,a.CALENDAR_DATE))+1,120),120) --this gives first day of month
AND b.CALENDAR_DATE <= a.CALENDAR_DATE
and month(b.CALENDAR_DATE)= month(a.CALENDAR_DATE))
      else row_number() over (
            partition by datediff(m,0,a.CALENDAR_DATE),a.IS_WEEKEND_HOLIDAY
            order by CALENDAR_DATE) end
from dbo.TIME_DIM a)

update holiday_weekends set WORK_DAY_NUMBER = setto


3) This last part updates the Working Day number when it is still 0 because it is the first day of the month and I set it to 1 to match the first working day in that month.

--update Working Day Number when it is set to zero because it is the first day of the month
update a
set a.WORK_DAY_NUMBER = 1
from dbo.TIME_DIM a
where a.WORK_DAY_NUMBER = 0
END

This would have worked as well, a quick tweak to my query above.

update a
set workdaynum = isnull(b.workdaynum, 1)
from tbldates a
outer apply (
      select top(1) workdaynum
      from tbldates b
      where b.thedate < a.thedate and b.thedate > a.thedate - 31
      and MONTH(b.thedate) = MONTH(a.thedate)
      and b.workdaynum > 0
      order by b.thedate desc) b
where a.workdaynum = 0

Thanks, I will keep a copy of that.