All managers know the scene. Hours are spent over spreadsheets. Days of meetings, discussions and debates. Draft budgets, revisions and redrafts. Months are spent estimating this that and everything down to the last paper clip. Finally the budget is accepted. Yet even by the end of Week 1, most assumptions the budget was built upon will be out of date, the constraints set will be inhibiting action and business opportunities will be lost.
Fixed budgets don’t work today. A budget is a too static instrument and locks managers into the past - into something they thought last year was right. To be effective in a fast moving economy with rapidly shifting market conditions and quick and nimble competitors, organisations have to be able to adapt constantly their priorities and put their resources where they can create most value for customers and shareholders.
Budgets, as practiced by most organisations today should be abolished! A growing number of companies have decided that conventional budgeting is no longer worthwhile. To them, the reassurance budgets give to a nervious chief executive is outweiged by the flexibility needed in todays organisations.
The weaknesses of traditional budgeting processes have been the subject of much attention and many commentators. Hope and Fraser consider that such weaknesses include the following:
• Budgets prepared under traditional processes add little value and require far too much valuable management time which would be better spent elsewhere.
• Too heavy a reliance on the 'agreed' budget has an adverse impact on management behaviour, which can become dysfunctional with regard to the objectives of the organisation as a whole.
• The use of budgeting as a base for communicating corporate goals - setting objectives, continuous improvement etc - is seen as contrary to the original purpose of budgeting as a financial control mechanism.
• Most budgets are not based on a rational, causal model of resource consumption, but are often the result of protracted internal bargaining processes.
• Conformance to budget is not seen as compatible with a drive towards continuous improvement.
• Traditional budgeting processes have insufficient external focus.
Rolling or perhaps monthly budgets focus management attention on current and likely future events. But is this managing change? Or merely an attempt to keep ahead of change.
‘Beyond Budgeting’ could be the answer. ‘Beyond Budgeting’ is about releasing people from the chains of top down management and enabling them to use the knowledge resources of the organisation to increase profitability. With intellectual assets accounting for 80-90% of shareholder value today, people really are the organisation’s most valuable asset. But the way the annual budget round works means that their energy is used more for negotiating the budget than creating shareholder wealth.
In the private sector managers should consider current and future opportunities with a focus on non-financial ‘value drivers’ as performance indicators. This should create and foster a climate based on competitive success. Goals are agreed against external benchmarks rather than against internally negotiated fixed targets. Managerial focus shifts from beating other managers for a slice of resources to beating the competition. It empowers operational managers to act by removing resource constraints. Key ratios are set, rather than detailed line-by-line budgets. Access to resources is based upon agreed parameters rather than line-by-line budget authorisations. This is aimed at speeding up the response to environmental threats and enabling quick exploitation of new opportunities.
Can ‘Beyond Budgeting’ work in the public sector? This would require a change in mindset. Senior managers and politicians would need to set broad goals and trust in their managers to ‘get on with it’ One of the biggest problems confronting the public sector is how do they best utilise their limited resources to meet the public’s unlimited needs? The problem we have today is that in the public sector the budget process is often about justifying existing resources and acquiring new resources. Priorities are based upon budget submissions and taken by people far removed from the action. Resources are then allocated for the year ahead. If ‘resource ‘buckets’ were allocated to users and they had the scope to spend the money in the way they thought best to maximise their performance and they had the information to understand their inputs and the flexibility to buy their resources from an internal or external market then they might have the incentive to take a long look at their costs.
Kaplan (no relation!) provides an interesting example. In the City of Indianapolis and after many years of budget overruns the new mayor decided to put a number of contracts out to tender. One included the paving of roads, filling potholes, sweeping streets, and collecting rubbish. He first asked for current costs. No one in the council had a clue. He then commissioned an a costing study. This showed a different view of costs. He then shared the information with departmental workers who decided to bid for the contract. Armed with the new information, the workers’ bid was by far the lowest cost ($286 per ton against the previous cost of $640). Cost savings came from fewer supervisors, reduced work crews (labourers vehicle drivers, and equipment operators) and more efficient use of vehicles. The lessons learned was that once the full information was shared with the workers (they had no idea about the central service costs), and once they had the freedom to act, they were in the best position to make improvements.
References:
Coombs, H M and Jenkins, D E Public Sector Financial Management, 3rd edition, Thomson Learning Press, 2003.
Hope, J and Fraser, R Beyond Budgeting, 1st edition, Harvard Business School Press, 2003
www.beyondbudgeting.org
Robert S. Kaplin Indianapolis: Activity-Based Costing of City Service
