So how do we know if our own budget process is successful? Set out below is a framework to make that judgement, starting with the barriers that have to be overcome. These include:
- poorly formulated (or no) objectives;
- confusion between objectives and constraints - planning and control are essential, but this does not mean imposing one particular way of doing things;
- poor implementation - many budgets are disliked because the process is dysfunctional. But this is not about budgets. It's about the way budgeting is done;
- absence of comparisons - if finance staff rarely leave and there is no outside scrutiny, there may be little awareness of what's going on elsewhere;
- results can't easily be linked to outcomes - it's easy to lose track of the impact of the budget. But is it reflective of good budgeting that we always meet our plan, or of bad budgeting when everyone bids low to hit the target? and
- not enough emphasis on quality - budget mechanics are pretty obvious but the quality of the outcome is rarely considered.
Taking action
So what's to be done? Assuming you are directly responsible for the budget process or a key player in deciding what form the budget takes, the buck stops with, or at least near, you. Three ways to improve the measurement of the process are to clarify the objectives, get better measures and recognise the limitations of measurement.
Clarify the objectives
The term 'budget' is used in so many different ways that clarifying objectives has to start with defining the process. It can cover annual or rolling forecasting and planning. It is very likely to include the basis for control, authorisation, coordination and performance evaluation. It is also likely to be linked to other processes, including strategy, costing, risk management and value analysis. It may be used as a means of signalling, discussing, communicating and gaining commitment.
Once the budget process has been defined, objectives can be set out. Without them, the budget will be no more than a means of reconciling, more or less messily, a collection of individual managers' wish lists.
The objectives will need to strike a balance between a number of managerial tensions. These include:
- the need for adequate time for consultation and reflection before the beginning of the year, set against the need for shorter lead times for key forecasts; and
- the need for adequate flexibility in forecasts, balanced with the need to have a basis for resource planning and the danger of excessive time in rebudgeting.
Who's to do this? While it must be the responsibility of finance, other key players - the board or executive committee, senior line and functional managers and finance itself - need to be involved.
The results then need to be spelled out and communicated to all those involved in the budget process, which probably means almost everyone. Good communication plays a big part in turning unwilling form-filling into commitment.
Objectives of budgeting
These will be specific to an organisation's needs and should be reviewed each year, but some examples are set out below.
In preparation, budgeting is intended to provide:
- a robust foundation for plans for the coming period within the strategic network, recognising the need for flexibility and current priorities, and linked to the risk register;
- the basis for performance measurement and control in a way which reduces the risk of divergence between individual and corporate goals;
- opportunity to discuss choices for the coming period widely, within and across units and functions;
- authorisation procedures which combine accurate monitoring with commercial flexibility; and
- recognition of the high cost of time for those involved and incorporating best practice.
After completion, its purpose is to provide:
- an agreed basis to proceed on the basis of commitment;
- an opportunity to communicate the overall results and their implications; and
- lessons for the improvement in the process for the next cycle.
Get better measures
These should cover both content and process and will need to be thought through in terms of the objectives and culture of the organisation. There are plenty of possibilities. On content, for example, success might be about how well risk analysis is integrated into planning, whether key projects are separately identified, and the quality of supporting non-financial (including intangible) measures.
The quality of the budget process also needs to be reviewed each year. Is it about spending a lot of precious time going through the motions, filling in the forms and then raising last year's figures across the board by 5%? Or does it add value by considering new opportunities, using forecasts to review assumptions about priorities and reassessing risk? And at the end of the process, is there commitment to the outcome? The level of detail needs to reflect the desired control framework; otherwise, with too much detail, there is a danger of micro-management.
Success could be about mitigating the perverse effects of control systems which rely on fixed targets in an uncertain world. This is not about the meaningless question 'Should it be top down or bottom up?' (answer: 'A combination of the two'.) but about setting a workable baseline while managing the inevitable game-playing. The means to do so might include varying timescales within an annual framework, using budget revisions during the year to mitigate pressures, or going for rolling budgets.
Or success could be about making sure that the budget supports remuneration and recognition by giving appropriate incentives and avoiding perverse incentives. It might be about introducing variety without unnecessary complexity through, for example, periodic in-depth scrutiny of different parts of the budget each year. It could be about helping to break down administrative silos by focusing on projects, customer groups or risk areas.
Tension (or lack of it) in budgeting, on the other hand, is not a suitable measure of success. Tension is inevitable when managers bid for a limited pool of resources. So success will be about how tension is managed and how far people feel they are involved in, and committed to, the outcome of the discussions.
A questionnaire may be one way to get the information about whether the process was successful, but it's probably better, a few weeks after the next budgeting process, to discuss what happened with colleagues. Their views will build a picture for improvement, though prompting may be necessary if a colleague doesn't have experience of more than one way of doing things. In any case, be careful to give enough time to explain.
Of course judgement about what people say is also necessary. Budgeting is not about popularity, and anyway, most of the costs are borne by participants and most of the benefits flow to the organisation as a whole. But if there is a strong and widespread belief that the whole process takes too long or does not add value, there will need to be better communication and/or changes in the next budgeting round
There's plenty of information on best budgeting practice, not only in print, but from conferences and informal discussions.
Outsiders - the non-executives, the auditors etc - should be asked for ideas. Find out from them how others judge budget success. And don't ignore good practice inside your own organisation.
Recognise the limitations of measurement
There won't be a final cost benefit figure for the budget process. Many of the benefits, whether in better planning, resource allocation, control or any other aspect, are intangible. Similarly, while some costs can be identified, budgeting is usually a part of what a lot of people do, and a definitive calculation of the time they spend may be accurate but is certainly hazardous.
In any case, the cost comparison is with what people would be doing if they were not budgeting and the benefit comparison with the effects of how much better the organisation would manage itself using an alternative process. Even with a full transition to a radical alternative, such costs and benefits will be largely intangible.
Recognition of the limitations of measurement is not an argument against constant appraisal of the budget process, but an acknowledgment that in any assessment, costs and benefits should be part of a commentary, not just figures based on dubious assumptions.
So a verdict will likewise be a judgement. This is not a second-best to numbers. As accountants know well, numbers, too, include judgements and have to be interpreted.
Conclusion
An assessment of this kind does not have to be complex, and a bit of time spent each year looking for improvements will be well spent. Judging by the level of complaints in most organisations, better measurement looks like a one-way bet. A winning one
Author
Sir Andrew Likierman is professor of management practice at the London Business School and a past president of the Chartered Institute of Management Accountants.
This article was published by the Finance and Management Faculty (Issue 136, September 2006).
