Budgeting

"OK Finance, here's your budget. Purchasing, here's yours, Operations, yours. Any questions? All right, thanks for meeting, let's make this year a profitable one."

For decades companies have been budgeting around functions, usually in the form of departments. The assumption has always been that if we hold our departments or functions to a specific budget, the whole place will run more efficiently. But does it? When a department head has a budget, and works hard and meets that budget, does DOES the company do better?

I am going to show you that it does NOT.

And that's not all. Not only does functional budgeting automatically limit the financial performance of the organization, but it also DRIVES division, PROMOTES conflict, and REWARDS selfish behavior. Really.

The Budget What's the purpose of a department budget? Well, let's break it down. First, a budget provides a guide for decision making. Whether a manager is buying supplies, allocating staff, purchasing equipment, or planning for employee training, the budget sets up the priorities the director should use to make the final decision. Second, a budget provides accountability. A solid budgeting approach means that the manager will be held accountable for the budget decisions made. This doesn't just mean "Did you stay within budget?", but it should also include "Was it the best deal? Will it last? Does it do the job?" Third, a budget helps set the culture of the organization. The items in a budget define what the company thinks is important. Do we want high customer service levels? Items in the budget should reflect that. Is employee retention important to us? There should be budget items that provide for employee satisfaction. Fourth, and usually most important to executives: the department budgets, collectively, should limit organizational expenditures and promote efficiency among departments. After all, that's why a lot of executive thought goes into "which department will need the money for what?" This fourth purpose is the most faulty in functional budgeting.

Driving Division The first thing a functional budget does is to focus attention on the DEPARTMENT. Not on the core process, not on delivering a quality product, not on smoothing flow through the organization - but on meeting my department budget. Consider the thought process that follows receipt of the new budget by a manager when the budget is tight, as is the case in many organizations in the United States today... "Gee, how am I gonna pull this off? I've got to schedule staff, but I've got to we don't go over budget; there's a lot of money tied up in payroll here. Wait, Sally just got chewed out for going $1000 over budget last month, she's gonna lose her bonus for that. I'm not gonna have that happen to me. Ha! I can cut staffing a little on the night shift, and that will save me a bundle. Hmm, that'll mean we may not have everything ready in the morning for Bob's department, but that's just tough, he'll have to learn to live with it."

Promoting Conflict Now, if there's not a lot of communication between departments, it may be a while until Bob finds out, but he WILL find out, because his own staff will let him know. Ever hear anything like this? Bob: Doggone it Doug, your folks didn't have the stock ready when we started up the line this morning! What's going on? Doug: Listen Bob, they've cut my budget this year, and I can only put five people on at night. I'm sorry if that causes a problem, but it's just the way it is. Bob: But how am I supposed to meet the quota, you know we've got that big shipment due this Friday? Doug: I wish I could help you, but this is the best we can do. Sorry! Bob: @#$%&@%!!

Rewarding Selfish Behavior That same tight budget can have interesting effects on supply departments, especially when there's an incentive tied to it. All right, I've got the budget numbers, and my people are gonna flip if I can't find some way for us to cut supply costs. How am I going to do this, I don't want to hear griping all year long... I know, Pterydactyl Supply has that leftover shipment of 5.8 volt batteries they made for that European company that went belly up. Sue said she has a whole shipload of 'em in the warehouse, and she'll cut anyone a deal who will help get them off her hands. That would bring us in $10,000 under budget 'cause we use a ton of the things - even if ours are usually 6 volts. I'm going to look VERY good to the CFO! And so, we're back to the conflict again: Irving: Sam, is anything going on with the batteries? All our testing equipment is starting to act funny. Sam: Nothing special. I just took a whole year's supply in and saved the company a lot of money. They're a little bit lower voltage, but it's small enough that it shouldn't have any effect on your equipment. Are they lasting as long as the old ones did? Irving: Well, they last just fine, Sam, but the readings are erratic, and it's making us have to redo a lot of the testing. I'm not even sure that the last batch of product was all within specs. Sam: It's probably not the batteries. I think you'll have to look somewhere else to find the problem, Irving.

Needless to say, the costs in rework, down time, and lost customer satisfaction were astronomically higher than the original savings. And guess what? This was a REAL case the really happened!

For budgeting to drive performance, it has to be built around processes, but that's another story.