Driver Based Budgeting

Driver Based Budgeting is a process that links real resources and activities to the financials in the budgeting process. This is usually achieved with support of a computer system that enables the process of planning and budgeting to be managed.

In many ways this approach is similar to traditional planning and budgeting, but the link to physical resources and real people makes the difference.

The process starts with the sales department doing their budget. They need to input the products, volumes and prices they expect to achieve in the next period. They will also need to input how the sales will be achieved and the rules that underpin each of the channels to market. For example, if sales are won by sales representatives, the number of calls, the number of quotations and other activities will be entered as rules, so the modelling of adding or reducing the sales force can be undertaken. This allows the business to model the impact of activity on sales, and the impact of price increases or discounts extremely quickly. But it also passes on very specific information to the rest of the business. Once the sales have completed this activity, the sales input is locked and the operations department is required to do their budget.

Operations will then plan their activities on the sales forecast. They will calculate the resources required, both in terms of people and equipment to deliver this budget and encapsulate these in a set of rules. That means if at a future date, the details of the sales forecast change, then the operational requirements can be automatically updated to reflect the new forecast. Having completed this activity, the operations budget is locked and logistics are allowed to do their input.

This continues until all the departments have completed their budget and the result is a model of the company which links physical activity to the costs.

The rules in the model enable the Driver Based Budgeting to work, but they also have consequences. If you change a rule, you need to explain why the rule is changed? You can’t simply improve the efficiency of your call centre staff without explaining why this has happened. Is it because you have simplified the process, provided faster computer systems response, or ...? This stops people shaving a few percentage of the budget each year, because the rule links the physical activity with the costs. But it also has the benefit of allowing you to ask questions such as  “what would be the cost saving of speeding up systems responses by 2 seconds a search?”

Hotel Group is a privately-owned small hotel group who own and operate hotels under several well known brands.  The company was founded in the 1990s and from there has gone on to develop and buy hotels.  

There was a belief that better planning and budgeting would improve cost control, facilitate better decision-making and improve profitability.  To this end, Hotel Group embarked on a project to upgrade their planning and budgeting system. The project involved developing an understanding of the corporate requirement.  Through surveying the senior executive team, a short list of tools and features was identified.  

The new planning and budgeting process allows Hotel Group to separate responsibilities into the different specialist areas.  Many of the services and supplies used by the hotels are negotiated centrally.  These central functions could then build their models covering the contracts they had agreed and the hotel operating staff were given the information against which to manage.

For example, the executive in charge of housekeeping for the group centrally negotiated contracts for towels, room cleaning and public area cleaning.  They also planned replacement of soft furnishings such as pillows.  These contractual arrangements were then built into the central model for all to see.  Changes in contractual arrangements could be simply input, evaluated and communicated.  Requirements and actuals could be compared and variances controlled.  In addition, replacement of standard items could be managed in line with company policy, ensuring customer service standards continue to be met.

For instance, cost control relies on managing key ratios.  The cost of food as a percentage of the restaurant bill price is one such ratio, as is the cost of drinks as a percentage of the bar price.  Through the new budgeting process, it was very clear that these ratios were set by the group with the local operating management having responsibility for delivering these ratios on a day to day basis.

For example, central costs such as depreciation, rent, gas and electricity can be input centrally.

As a result of this, some managers feel that “they are not controlling their own budgets any more”. Central accounting’s response is that “they never did”! What the new system does is starkly contrast those costs that are the responsibility of local management and those managed elsewhere. Other managers now have greater insight into the level of detailed planning that is done in other parts of the business, to ensure adequate cost control and consistency of service delivery.

This company has a traditional planning and budgeting process but moved to driver based budgeting to increase speed and accuracy of the budgeting process.

For example, the company had a number of key budgeting drivers that the system was able to replicate. One of the main costs in distribution is staff. Depots were able to input the numbers and skills being used with the costs being calculated using the 25 different grades and rates from the centrally held pay table. 

Many of the depot costs are not controlled by the depots but centrally negotiated. Insurance, utility costs and rates were all input centrally into the depots budget, giving control to the functions who had negotiated these contracts whilst freeing up depot management time to focus on their key cost drivers.

Fuel is also an important cost for distribution and the cost changes rapidly. With recent volatility in oil prices, fuel costs are difficult to control. In this company the fuel budget is generated from historical data on average fuel consumptions and local depot estimates of kilometres to be travelled. Putting in a central price per litre allows changes in fuel costs to be rapidly calculated and the impact assessed right across the UK business.

Finally, parcel size and shape has an impact of handling costs. The majority of parcels can be sorted by machine, but there is a significant proportion that is not machine compatible and has to be handled manually. The system allowed depots to be allocated hub costs based on their mix of standard and non-standard freight. This better reflected business realities of the business processing and created an environment for better decision making.

• 12 weeks’ saving in the time taken to undertake a new budgeting round, 
• Head office consolidations were reduced from a week’s work to half a day. 
• Budget quality improved with a wider understanding outside finance of the budgeting process and what it means for the business. 
• The new approach enabled “bad” budgets to be quickly and easily recognised. 
• Even staff, who have had difficulty with budgeting in the past benefited from the new system, with one senior executive having “done his best budget in nearly 15 years”. 

Finally, there was much less game playing. In the past, for some, the budget process was real theatre with aggressive negotiation on both sides. The linking of the financial numbers with physical activity has greatly reduced the ability of managers to build in slack or pad costs. Reviews are now much more realistic as they are based on facts, rather than unsubstantiated judgements.

• It speeds up the budgeting process as it turns the budget into a shared business model.
• It makes budgeting quicker.
• It makes re-forecasting much simpler and quicker, so the impact of events can be quickly assessed.
• It takes out the negotiating in the budget as the rules determine the resources required in most cases.
• It allows the redistribution of accountability and makes it very clear what people are responsible for.
• It works particularly well in companies with a branch structure or many similar local activities (e.g. hotels, retailers, builders merchants, restaurant chains) as one set of rules can be applied across the business and performance compared.

• Don’t make the model overly complicated.
• When building the budget, focus on the rules.
• Don’t leave the rules completely to the accounts department; they understand the numbers but not the rules. This is a great opportunity to engage line management and the opportunity should not be lost.
• You can’t make people responsible for activities outside their control. You will need to change your management practices to fit the new distribution of responsibilities enabled by this approach. 

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Further reading on innovations in budgeting is available through the resources below.