Why Budgeting Fails, Part 2

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Presentation-quality budgets.

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An Advanced Budgeting System:

  1. Align budgeting to strategy. An advanced budgeting system will integrate the planning and review processes. The Balanced Scorecard is a helpful alignment mechanism for this purpose.
  2. Link relevant nonfinancial performance measures to budgeting. Financial data is a lagging performance indicator. Focus needs to be on important performance drivers – both financial and nonfinancial.
  3. Reduce detail through the use of aggregated budgets. Many companies have taken the first step toward reducing detail by focusing budgeting on major product groups, organizational units, processes, and cost types. Aggregating involves giving leaders discretion in allocating resources to departments and activities under their jurisdiction instead of documenting every single departmental cost.
  4. Use rolling budgets instead of fixed budgets. In competitive and dynamic marketplaces, companies need more frequently updated budgets so they can adapt to changing conditions. Therefore, the best budgeting systems use such approaches as the five-quarter rolling forecast. Constantly focusing management on the next five quarters helps to balance short- and mid-term thinking.
  5. Use relative targets instead of a fixed budget to reward people. Instead of encouraging managers to meet their fixed budget, I suggest measuring success by comparing manager performance against relative, self-adjusting performance measures whenever possible. Relative targets can motivate the right behavior, guiding people to act in the company’s best interest. It is better to assess performance based on benchmarks. Managers today should be rewarded for achieving a set of nonfinancial as well as financial objectives. Today’s companies incentivizes such performance by basing bonus compensation on multiple factors, not just on whether the manager makes their numbers.
  6. Increase the focus on processes instead of on departmental and organizational unit performance. This reflects the idea of managing processes to drive success in the marketplace. It also focuses management on major cost drivers. Managers are more attentive to organizational strategy and goals.

Business planning is essential for business prosperity. Businesses, like people, don’t plan to fail – they fail to plan.  If you would like to learn more about how you can transform you business using the Bible as your guide, email me at info@commonsensecfo.com.

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Why Budgeting Fails, Part 1

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The Problems with Budgeting:

  1. It’s inefficient. The traditional budgeting process takes too long and consumes too many management resources.
  2. It rapidly becomes obsolete. With their annual focus, most budgets are outdated soon after they’ve been set.
  3. It doesn’t motivate the right behaviors. Traditional budgeting fails to move people to act in their company’s best interest. It encourages bureaucracy and dysfunctional behavior instead of entrepreneurship. Managers can deliberately lowball their financial targets to make their performance appear better.
  4. It’s out of sync with the strategic plan. Perhaps most important, traditional budgeting emphasizes financial performance over and above the pursuit of strategy.

 

The Traditional Role of Budgeting – Designed to Serve Three Main Purposes:

  1. Coordinate the organization’s financial activities and picture. The point of the budget isn’t merely profit planning; it’s designed to align the individual units to the organization’s strategic and operational objectives.
  2. Communicate financial expectations. A budget is designed to give managers a clear understanding of the company’s financial goals, from expected cost savings to targeted revenues.
  3. Motivate managers to act in the company’s interest. Rewarding managers for achieving challenging objectives is probably the most important – yet most debated – function of budgeting. Budgets more often than not encourage dysfunctional behavior such as “padding” or “slacking”.

 

The real problem is that the traditional approach to budgeting is no longer suited to the realities of today’s dynamic business environment. Companies that continue to rely on the budgeting system as their only management system are following a prescription for failure.

 

Business planning is essential for business prosperity. Businesses, like people, don’t plan to fail – they fail to plan.  If you would like to learn more about how you can transform you business using the Bible as your guide, email me at info@commonsensecfo.com.

 

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