M3578

Budgets run into trouble because they are trying to do too many things at once. It is not reasonable to assume that they should be able to do so many things, which is why I think of the present situation as a “budget morass.”

Consequently, part of the solution is to parse what budgets try to cover off and rebuild the process.

Here is what budgets try to do, and which seems reasonable enough on the face of it.

  1. Quantify goals from the planning process
    • Planning = goal setting and broad outline of activities
    • Goals = the desired future
  2. Act as an unbiased forecast
    • Forecast = estimate of possible outcomes
    • Budget = financial implications of forecasts
  3. Guide resource allocation
    • Resource allocation = Best use of funds available
  4. Provide basis for bonus determination
    • Bonus = incentive pay linked to performance

Instead of trying to do all that with one number (the budget), why don’t we just break it up by separating out:

  1. Target setting
  2. Forecasting
  3. Goal setting
  4. Resource allocation

Target setting

Target setting starts with the identifying the strategic objectives and describing the major change areas and the practical time horizon expected for realization of these objectives.

Along with the objectives, define how the outcomes will be measured (i.e., in order to prove their realization) and what the performance targets are.

Target setting identifies what we should do.

Now hand this high level picture down to the lower levels in the organization.

Forecasting

A strategy without an action plan is of no use and will most likely fail to achieve anything. Therefore the next step is to relate the strategic objectives to specific processes and identify high level activities that must be completed to realize the objectives.

For each action, identify how to measure outcomes.

Now create forecasts for the necessary actions.

These forecasts identify what we can do. Already, it should be clear that forecasts are likely to be different from targets.

Of course, we need to look at how we can close the gaps between expectations (targets) and what we think we can do (forecasts). However, at some point, the two may be irreconcilable. Even if we manage a fit at the outset, it is also clear that as life goes on, the two may drift apart in ways that cannot be mitigated completely.

Consider this:

  • Differences confirm we are aiming high while having a realistic view of where things are headed
    • Remember: we’re trying to close the gap with our actions – make sure they are focused on the right things
  • Do resolve conflicts (i.e., uncomfortable differences)
    • E.g., do a target review after planning (only adjust targets down, never up otherwise we’ll not get a forecast above target ever again)
    • E.g., do a holistic assessment at performance evaluation (e.g., how ambitious were we really? Too much? Not enough?)

Budgets cannot be expected to be both targets and forecasts; something has to give, so keep the two apart.

Now hand the forecasts over to the organization for team or individual goal setting.

Goal setting

In order to achieve alignment from top to bottom in the organization, the goals of the teams and individuals must be related in a meaningful way.

This is where the goal setting process comes in. From this process we get commitment from individuals and teams behind low level and detailed outcomes measured in ways that everyone can understand. (Well, that’s the theory, anyway.)

At this point, we must remember that individuals, and most teams, have only a very limited ability to change the way the organization works. This means that the existing organizational structure, systems and processes will determine the majority of the outcomes.

For this reason, we will fail if we do not back up expected changes with initiatives to alter the structures accordingly. This is a common failure point, because our organizations do not generally appreciate how little power individuals have influence outcomes.

Resource allocation

While we can always debate the proposed level of effort, most annual budget cycles do include consideration of major changes such as capital investments and various projects.

The normal routine makes the organization prepare a batch load of project funding requests that go into a centralized and time consuming prioritization process.

Essentially, the Treasure function acts like a bank, but if we think about it, the Treasury operates not at all like a bank., In fact, if your bank operated like the Treasury, we would move our business to another bank.

Check this out.

Treasury practice Bank practice
  • Open four weeks in October
  • Open year round
  • Only processes project funding requests at this time
  • Processes project funding (loan) applications year round
  • Only approves projects at this time
  • Approves projects year round
  • Variable acceptance criteria
  • Consistent acceptance criteria
  • Open back door to circumvent standard procedure if you have the Treasury Door Lock Secret Decoder Ring
  • No back door – one process for everyone. In fact, the secret Bank Door Lock Secret Decoder Ring leads straight to jail

The centralized project funding method effectively reserves funding today for things we will not do until over a year later. We do not actually expect to put aside cash for this now. We expect to make financing available when the projects are closer to being kicked off. Since there is no linkage between today’s decision and the subsequent cash flow (outflow), why are we earmarking funds at this early date?

The better approach is to say something about the level of funding necessary to do what needs to be done in the year and then entertain project funding requests on a continuous basis.

This is not anarchy; it is simply realizing that if a project we can do now has benefits, we should do it. In addition, the project request and estimates for something imminent is a whole lot more accurate than some wild guessing 12-15 months ahead of time for something that could and maybe should look entirely different a year later.

This is also not just a first-come first-served mechanism that could give less deserving projects money simply because they got to the fire hose before others. Take a look at the bank model where it says “consistent acceptance criteria”. This is key; if the project makes business sense, do it – if not, don’t. What’s so hard about that?

Obviously, the above approach must be tempered somewhat to accommodate the larger, strategic initiatives that require significant funding and so on and must be tackled with a long time horizon in mind. This is just common sense, but still leaves a considerable chunk of funds to be administered on an ongoing basis.

Final words

There is more to this, of course, because making sweeping changes like proposed here requires considerable commitment and attention to detail. That said, there is ample real life experience to learn from in Europe and North America so there is no need to go it alone.

Sources

Bogsnes, Bjarte (2009). Implementing Beyond Budgeting – Unlocking the Performance Potential, John Wiley & Sons, Hoboken, NJ.

dot The way out of the budget morass